The Northeast Power Coordinating Council (NPCC) comprises American states and Canadian provinces marked by asignificant penetration of variable renewable energy sources (VRES) and hydropower production. Major demandcentres in New England, New York, Ontario, and Québec that are subject to stringent to stringent caps on CO_2emissions are included in the NPCC. For example, the Regional Greenhouse Gas Initiative (RGGI) mandates a 30%reduction in CO_2 emissions from power plants by 2030 relative to 2020 levels, which affects generation in NewEngland and New York. Likewise, Québec participates in the Western Climate Initiative (WCI), which aims toreduce CO_2 emissions by approximately 40% by 2030 relative to 1990 levels and included Ontario until recently.Both RGGI and WCI create cap-and-trade (C&T) systems for CO_2 emissions in which the shadow price on thebinding CO_2 emission constraint is the permit price that generators incur as an additional cost for their CO_2emissions. While support schemes such as feed-in tariffs and the C&T system have induced an increase in VRESgeneration, they have also enhanced the role of energy storage, viz., by hydro reservoirs especially in Québec. In aperfectly competitive power system, storage capacity would be deployed in a socially optimal way to smooth out thefluctuations in uncontrollable VRES output (Bushnell, 2003). However, given the persistence of market power in theelectricity industry (Tangerås and Mauritzen, 2018), hydro reservoirs may be used in a strategic manner to thebenefit of their proprietors. Consequently, incentives for VRES and social welfare may be detrimentally affected bysuch exertion of market power. In order to investigate the extent of these distortions in the NPCC and to proposepolicies for their mitigation, we develop a bottom-up equilibrium model to quantify the welfare losses from thestrategic use of hydropower reservoirs and to assess counterfactual CO_2 emission caps.
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