With the deepening of reform, China’s electricity market is anticipated to be much more competitive than before. In effect, the cost pass through mechanism will be progressively established, making it possible for power industry to transfer their carbon cost downwards. This may significantly influence the design and development of the national carbon market from perspective of tackling with potential carbon leakage risk, which is one of the most critical environmental issues considered in China during the process of enacting mitigation policies. Conversely, the national carbon market to be started by the end of this year will set clear price signal for the CO2 emissions, and thus might also affect power generators’ attitude towards the electricity market reform. Hence, this paper explores the interaction between electricity market reform and carbon pricing in China through a strengthened scrutiny for carbon leakage. It turns out that whatever the allocation approach is, the feedback from power generators is to appeal a faster reform progress. For those sectors as participators of carbon market, allocating 15.8% of total emission permits for free is sufficient to compensate those sectors deemed at risk of carbon leakage in regulated electricity market, whereas the fraction varies from 7.9% to 17.0% under various cost pass-through scenarios. Meanwhile as the reform will drive electricity pricing system to be more liberalized, it will also incur additional cost to those sectors outside carbon market. It indicates that the compensation measured as equivalent free permits in different scenarios remains positive correlation with the reform progress expressed as increasing cost pass-through rate, up to 5.6% and 4.5% for scenarios with and without carbon tax.
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