A Market Design Proposal for Decoupling Carbon and Electricity Prices

In European day-ahead electricity markets, carbon allowance costs passed through by marginal fossil plants raise consumer expenditure and generate inframarginal rents for non-emitting generators. We propose a settlement modification: when the zonal day-ahead price exceeds a threshold, non-emitting generation is remunerated at the clearing price minus a fixed CO2-proxy deduction, while all other units continue to receive the uniform price. The mechanism thus reallocates a part of the inframarginal rents to consumers. Using hourly data we estimate static average expenditure reductions of about 8.5 percent in Austria and 4.7 percent in Germany in 2025. We discuss bidding incentives around the threshold, interactions with Contracts for Difference, implementation in coupled bidding zones, and a gas-cost variant for the 2022 energy crisis.