The magnitude of the impact of a shift from coal to gas under a Carbon Price Liam Wagner n , Lynette Molyneaux, John Foster Energy Economics and Management Group, School of Economics, University of Queensland, Brisbane, QLD 4072, Australia HIGHLIGHTS  Marginal cost pass-through rates of increasing cost of carbon are established.  Market behaviour shifts to infra-marginal rent seeking under increasing carbon and natural gas costs.  Strategic behaviour of generators is established under these shifting conditions. article info Article history: Received 20 May 2013 Received in revised form 30 October 2013 Accepted 1 November 2013 Keywords: Electricity Markets Infra-marginal rent abstract We seek to evaluate the extent of the pass through of increased fuel and carbon costs to wholesale prices with a shift of generation from coal-fired to gas-fired plants. Modelling of Australia's National Electricity Market in 2035 is undertaken using Australian Energy Market Operator assumptions for fuel costs, capital costs and demand forecasts. An electricity market simulation package (PLEXOS), which uses deterministic linear programming techniques and transmission and generating plant data, is used to optimize the power system and determine the least cost dispatch of generating resources to meet a given demand. We find that wholesale market prices increase due to the full pass through of the increased costs of gas over coal as an input fuel and the Carbon Price. In addition, we find that wholesale prices increase by more than the pass through of fuel and carbon costs because of the fact that generators can charge infra-marginal rents and engage in strategic behaviour to maximize their profits. Crown Copyright & 2013 Published by Elsevier Ltd. All rights reserved. 1. Introduction The International Energy Agency (IEA) in its modelling of global energy demand and supply to 2035 predicts “a pronounced shift away from oil and coal (and, in some countries, nuclear) towards natural gas and renewables” (Steinhilber and Ragwitz, 2011). This view is supported by the recent development of shale gas resources in the United States that has delivered low gas prices and shifted electricity generation from coal to gas resulting in generation from gas increasing from 24% in 2010 to 31% in 2012 (EIA, 2013a,2013b). However, as the Energy Information Adminis- tration (EIA) points out, “In deciding whether to dispatch coal or natural gas for electricity, the price of fuel is critical” (EIA, 2013a,2013b), such that increases in gas prices in 2013 have reversed some of the recent trend towards gas. Notwithstanding the short-term perturbations currently result- ing in fuel switching in the United States, the IEA forecasts that the real price for gas in the US will rise to $8/MBtu by 2035 because “as demand grows in response to lower prices, costs rise and export capacity is built.”(Steinhilber and Ragwitz, 2011, pp. 43–44) Carbon dioxide emissions are at the end of a long line of concerns with the burning of coal. Heavy use of coal during the industrial revolution, caused significant pollution for Victorian England which impacted on health with smoke abatement clauses accompanying regulation to improve urban health (Brimblecombe, 2011). It was however in 1952 that the Great Smog of London, which was implicated for significant deaths, resulted in the Clean Air Act of 1954 the aim of which was, amongst other things, to switch fuel use away from coal (Brimblecombe, 2006). This was followed in the 1980s and 1990s, by attempts to reduce sulfur dioxide (SO 2 ) emissions from coal-fired generation in countries from Germany to the United States of America (USA) to deal with ‘acid rain'. So, as China is discovering, there are greater problems associated with the burning of coal, than just its CO 2 emissions (Chen and Ebenstein, 2013). With the IEA proposing a global shift from coal to gas to reduce emissions of carbon dioxide, national power systems are likely to experience cost increases as a result of the shift to a fuel forecast to be more expensive than coal. This shift is justified by a carbon Contents lists available at ScienceDirect journal homepage: www.elsevier.com/locate/enpol Energy Policy 0301-4215/$ - see front matter Crown Copyright & 2013 Published by Elsevier Ltd. All rights reserved. http://dx.doi.org/10.1016/j.enpol.2013.11.003 n Corresponding author. Tel.: þ61 7 3365 6601. E-mail addresses: l.wagner@uq.edu.au (L. Wagner), l.molyneaux@uq.edu.au (L. Molyneaux), j.foster@uq.edu.au (J. Foster). Please cite this article as: Wagner, L., et al., The magnitude of the impact of a shift from coal to gas under a Carbon Price. Energy Policy (2013), http://dx.doi.org/10.1016/j.enpol.2013.11.003i Energy Policy ∎ (∎∎∎∎) ∎∎∎–∎∎∎