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Renewable Energy 32 (2007) 976990 www.elsevier.com/locate/renene

Mathematical modelling of electricity market with renewable energy sources

O.V. Marchenko
Energy Systems Institute of Russian Academy of Sciences, 130 Lermontov street, 664033 Irkutsk, Russia Received 1 May 2005; accepted 9 April 2006 Available online 6 June 2006

Abstract The paper addresses the electricity market with conventional energy sources on fossil fuel and nonconventional renewable energy sources (RESs) with stochastic operating conditions. A mathematical model of long-run (accounting for development of generation capacities) equilibrium in the market is constructed. The problem of determining optimal parameters providing the maximum social criterion of efciency is also formulated. The calculations performed have shown that the adequate choice of price cap, environmental tax, subsidies to RESs and consumption tax make it possible to take into account external effects (environmental damage) and to create incentives for investors to construct conventional and renewable energy sources in an optimal (from the society view point) mix. r 2006 Elsevier Ltd. All rights reserved.
Keywords: Electricity market; Mathematical model; Long-run equilibrium; Renewable energy sources; External effects

The bar over the symbol denotes an average (for the short-term variations) value of the variable. 1. Introduction At present the most important trends in development of the world electric power industry are the following:  liberalization aimed at improvement of the economic efciency of energy production, transportation, distribution and consumption on the base of competitive market mechanisms;
Tel.: +7 3952 428861; fax: +7 3952 426796.

E-mail address: marchenko@isem.sei.irk.ru. 0960-1481/$ - see front matter r 2006 Elsevier Ltd. All rights reserved. doi:10.1016/j.renene.2006.04.004

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Nomenclature B1 B2 B12 BS b2 c ^ E E(t) f(x) N p p0 pmax Q QD Qm QRmax q q0 T v v* y(q) y0 a b DcR Dp DvF Dy dB12 dQ x s t Indices F R fossil fuel power plants renewable energy sources total producers surplus (US$/year) total consumers surplus (US$/year) total producers and consumers surplus (US$/year) social welfare (US$/year) consumer surplus (US$/year) xed electricity production costs (US$/kWh) net present value (US$) cash ow (US$/year) power curve number of consumers electricity price (US$/kWh) electricity price, reference point (US$/kWh) price cap (US$/kWh) amount of electricity produced or consumed (kWh/year) total electricity demand (kWh/year) maximum annual electricity production (kWh/year) maximum annual production by RESs (kWh/year) electricity consumption (kWh/year) electricity consumption, reference point (kWh/year) lifetime (years) variable electricity production costs (US$/kWh) specic environmental costs (US$/kWh) useful effect (US$/year) constant (US$/year) function of medium-term demand price elasticity b medium-term demand price elasticity investment subsidies to RESs (US$/kWh) consumption tax (US$/kWh) environmental tax (US$/kWh) specic losses from electricity undersupply (US$/kWh) losses of total producers and consumers surplus average electricity undersupply random variable discount rate (1/year) time (year)

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rapid development and introduction of new energy technologies, rst of all renewable energy sources (RESs), to mitigate an adverse energy effect on the environment, climate and public health.

In this context the question arises: to what extent are these goals compatible? Can the market mechanism secure sustainable development of the electric power industry with the parallel meeting of both economic and environmental requirements? As noted in [1], the main driving force of power industry liberalization was a widely held belief that competition will be benecial in a broad sense. From economic theory, it is known that in certain conditions (a great number of relatively small sellers and buyers, free admittance to the market, accessibility of price information, absence of technical constraints on production volume, and so on) the market equilibrium provides the optimal allocation of resources, i.e. the maximum economic efciency. In the electricity market, however, some of these conditions are not met. As distinct from other industries the electric power industry is characterized by a series of specic features. The most important of them are: (a) simultaneousness of electricity production, transmission and consumption in time; (b) variability of consumer load; (c) high capital intensity and long period of power plants construction. Therefore, the effectively functioning market of electricity cannot be formed spontaneously, but should be organized on the base of specic rules. Numerous studies have shown that inadequate efciency of the market and unreasonable price rise can be caused exactly by its poor organization [2]. Elaboration of the market rules and regulation methods, with consideration for both the specic features of electric power industry as a whole and the unique characteristics of power systems, is a very sophisticated problem which is yet to be solved. The known theoretical models [1,310] describe only some aspects of the market mechanism functioning. In terms of societys interests, the impact of different methods of market regulation on its efciency has been studied insufciently. Participation of energy sources with stochastic operating conditions in the electricity market introduces additional complexity to its theoretical analysis. RESs using wind or solar energy have uncontrolled variable output due to random variations of wind velocity and intensity of solar radiation. As a result the electricity supply volumes and its price in the electricity market change sharply. Expediency to utilize RESs is determined by their economic and environmental effectiveness. Substitution of conventional energy sources by RESs decreases thereby the amount of fossil fuel combustion and emissions of harmful substances in the environment. Emissions are external effects relative to the market, since the environmental damage is borne not so much by market participants (sellers and buyers) as the other subjects not participating in the market. To improve the efciency of electric power industry, the market should foresee mechanisms converting external effects to economic indices of market participants, i.e. of internalization of external costs and stimulating sellers and buyers to act in societys interests. Each country applies different economic mechanisms (environmental taxes, investment subsidies, feed-in tariffs, green certicate market) to promote RES development in a market environment (meeting the set quotas of their introduction) [1113]. However, there are no sufciently denite conclusions as yet about the expediency of choosing one or other mechanism out of possible alternatives.

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The goal of the work is to build a mathematical model of the electricity market with involvement of RESs with stochastic operating conditions and study the efciency of market regulation methods for provision of incentives for investors to construct conventional and renewable energy sources in an optimal (in terms of the society) mix. The model is intended not for the analysis of specic power systems, but for the study of general principles characterizing the relation between the current market equilibrium and long-term trends of power industry development. Therefore, it takes into consideration only the most signicant factors and dependences. Some specic features of the model are described in greater detail in earlier publications [14,15]. 2. Mathematical model In accordance with the specic character of the power industry, the model addresses three time periods: long-, medium- and short-term. In the long-term period (years), investors determine (project) the installed capacity of power plants that subsequently remains xed. In the medium-term period (months), consumers optimize their electricity demand (choose appropriate operating conditions) subject to the price situation in the market. In the short-term period (current market state), the system operator provides equality between electricity production and consumption, limiting electricity consumption, if necessary. In all the cases, each market participant (producers and consumers) acts so as to maximize the own surplus (the difference between revenues and expenses) accounting for the rules established in the market. 2.1. Long-term period The efciency of investment in new power plants is characterized by the predicted net present value (NPV): Z T ^ E E t expst dt,
0

where E(t) is the cash ow, s is the discount rate and T is the period of project implementation. Since the prices and electricity production and consumption in the market vary over time intervals (hours, days, months) that are considerably shorter than the time of changing the discount rate coefcient exp(st) and the variations are repeated cyclically, the non-negativity condition of NPV takes the form ^ 1 1 expsT pQ vQ cQm X0, E s where p and Q are the price and the amount of electricity produced and supplied to consumers, respectively, v and c are the specic variable and xed electricity production costs, respectively; Qm is the product of installed capacity of a power plant by its utilization hours per year (theoretically the maximum possible annual electricity production). Below the value Qm will be called, for short, capacity. Here and below, the bar over the symbol denotes an average (for the short-term variations) value of the variable.

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The value in square brackets is an annual average producers surplus B1 . If new participants can freely enter the market, the long-run equilibrium will be achieved at B1 0 for all types of power plants. This condition determines the amount of planned capacity Qm: at lesser capacity an additional prot will attract new investors, at larger capacity the investment will be not paid back. We will deal with two types of power plantsconventional ones on fossil fuel (index F fuel) and power plants on RESs that utilize wind or solar energy (index Rrenewables). Then the long-run equilibrium conditions take the form B1F pQF vQF cF QmF 0, B1R pQR cR QmR 0. (1) (2)

The fuel costs are the main component of variable costs v per unit of supplied electricity. The xed costs c include payments for the use of investment attracted for construction of power plants, repair expenses, wages, etc. The variable costs of operating and new (planned) power plants on fossil fuel are assumed to be equal, on RESsto be zero. The xed costs cF and cR are attributed to new power plants. It can be easily shown that consideration of the difference in xed costs of new and existing power plants means addition of the constant that does not inuence the results. 2.2. Medium-term period Let us consider only one consumer with the surplus b2 yq pq, where q is the electricity consumption; y(q) is the useful effect (for the producer of any product it will be his prot, for the nal consumerthe utility function) and pq is the consumer payment for electricity. At the given price p the consumer chooses electricity consumption q in terms of the maximum consumer surplus b2. The obtained dependence q(p) is often described by the demand curve with xed elasticity. Such an approximation corresponds to the assumption that at any installed capacity of power plants supply can always cover demand owing to the appropriate price change. If supply in the electricity market is lower than demand, the price rises and demand falls, until it is equal to supply. In fact many consumers or even their majority, especially small, do not respond to current price uctuations, since they lack relevant information and technical capability to respond to prices. The short-term demand, therefore, is usually inelastic [8] (absolutely inelastic, in the limit). The consumers determine their demand for electricity based on the general (average) level of prices rather than on their instantaneous values. Paying for the electricity consumed (or forecasting the costs for electricity supply), they take a decision on the possibility of maintaining their electricity consumption at the present level or the expediency of decreasing it (at high prices) or increasing it (at low prices). Thus, the market price p varies, but the consumers cannot continuously respond to these variations. They choose only the value q of electricity consumption in terms of the maximum average surplus b2 yq pq.

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Hence db2 dy p 0. dq dq (3)

If the function y(q) is known, dependence of electricity consumption on the average price qp, i.e. the equation of the medium-term demand curve, can be determined from (3). However, it is simpler to set this curve (based on the empirical data) to pass through the point (q0, p0) with the elasticity coefcient b: b q=q0 p=p0 , (4)

and then to determine the useful effect y(q). Substituting the price p from (4) into (3) and integrating with respect to the variable q, we obtain yq y0 p 0 q0 1 q0 =qa , a

where y0 is a constant and a (1+1/b). When the average market price p is known, the consumers choose their electricity consumption q from condition (4) in the medium-term period; then in the short-term period, this electricity consumption remains constant. 2.3. Short-term period Short-term changes in the electricity market are conditioned by rst, demand uctuations and second, variations in production based on RESs. Electricity demand is equal to QD Nq, where N is the number of consumers (taken to be identical). Assume that the number of consumers N, entering the market at the moment with the demand q, is a random variable with the known probability distribution. The electricity produced by RESs and transmitted to consumers is in the interval 0pQRpQRmax QmRf(x), where the last multiplier (0pf(x)p1) represents a power curve of RESs (dependence of the generated-to-installed capacity ratio on the random variable x, the factor characterizing meteorological conditions). The demand QD may be both lower and higher than the total available power QRmax+QmF depending on the random variables N and x. Fig. 1 presents three variants of the relation between QD, QRmax and QmF. The supply curve is determined on the assumption of perfect competition (the power plants offer electricity at prices equal to variable costs, the system operator establishes priorities of power plants by their efciency). At QDoQRmax the demand is satised completely only by electricity production by RESs, all power plants on fossil fuel are unloaded and the electricity price equals the variable costs of RESs that are assumed to be zero in the model. When QRmaxoQDoQRmax+QmF, the fossil-red power plants are partially involved in operation, the electricity price is equal to their variable costs v. If QD4QRmax+QmF, the demand cannot be satised in full. The system operator, therefore, limits electricity consumption (decreases to the level QRmax+QmF). The price in

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1 v Q QR max QR max+QmF

Fig. 1. Supply (1) and demand (24) curves.

this case remains uncertain, i.e. the market mechanism cannot automatically determine a clearing market price. In such situations, the price is generally set equal to the specied value of the price cap pmax at the level of the specic losses from electricity undersupply, as a rule within the range $110/kWh [8]. Thus in the short-term period we have:

at QD oQRmax QR QD ; Q F 0; p 0; (5)

at QRmax pQD pQRmax QmF QR QRmax ; QF QD QRmax ; p v; (6)

at QD 4QRmax QmF QR QR max ; QF QmF ; p pmax (7)

The total consumers surplus is B2 NyqQ=Nq pQ DyNq Q, where Q QR+QF is the total electricity supply to consumers by all the power plants and Dy is the specic losses from electricity undersupply. The rst term in this expression is the useful effect of consumers (the multiplier Q/Nq equals the share of consumers actually receiving electricity), the secondthe electricity payment, the thirdthe losses from electricity undersupply. By averaging, we have B2 y q Q pQ Dy Nq Q . q

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2.4. Market equilibrium Based on the above the problem of determining the long-term market equilibrium is formulated as follows: nd the values of variables QmF40, QmR40 and q40 from conditions (1), (2), (4)(7) where the Eqs. (5)(7) are written for all values of random variables N and x, and the average values (mathematical expectations) of functions are calculated by common rules. 2.5. Optimal solution A market mechanism in electric power industry may not provide maximum economic efciency of electricity production and consumption from the viewpoint of the society as a whole (hereof the system producers + consumers). Therefore, to estimate the efciency of different market organization methods it is sensible to consider the option of centrally set optimal values QmF, QmR and q. Here the efciency criterion is the mathematical expectation of the total producers and consumers surplus: B12 B1F B1R B2 . Note that the optimal solution is a reference for comparison only within the considered model where xed and variable costs of power sources are assumed constant. In reality the market creates incentives for decreasing these costs which, however, is practically impossible to take into account in the formal models. Thus, we have the problem: nd QmF40, QmR40 and q40 from the condition B12 y q Q Dy Nq Q vQF cF QmF cR QmR ! max q (8)

subject to (5)(7). 3. Initial data The calculations presented in the paper are of illustrative character, therefore the initial data assumed do not refer to any specic option. Nevertheless they do not differ much from the values that can be found in practical cases. Prices, costs and losses are expressed in terms of US$ (cents) per kWh; the remaining valuesin conventional units (the dimensionless parameters were introduced without changing the notations). Variable costs v 0.20 US$/kWh, xed costs cF cR 0.02 US$/kWh, specic losses Dy 1 US$/kWh, p0 0.22 US$/kWh, q0 1, y0 1, b 0.4. The variable costs v are chosen rather high to analyze the system with an essential contribution of RES; they correspond approximately to the costs of power plants on liquid fuel in the northern regions of Russia [16]. The value N is assumed distributed under the Gauss law (at a large number of consumers the variable N can be considered as a continuous value) with an average value (in conventional units) N 1 and mean square deviation 0.1. The load duration curve is shown in Fig. 2. Wind turbines of the company Lorax Energy Systems were considered as renewable energy sources. The variable x (here it is a wind velocity) is distributed by the Weibull law with the shape factor 1.5; the average wind velocity is 6 m/s [16]. For

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1.2

1.0 Nq 0 0.8 0.6 0.0 0.5 T 1.0

Fig. 2. Load duration curve (Tdimensionless length of the short-term period).

numerical calculations, 8760 sets of random values of N and x (for each hour of a year) were used.

4. Investigation of price cap inuence on market efciency For comparison let us take the solution to the optimization problem (8) as a base option, when QmFopt 1.341, QmRopt 2.377, qopt 1.133, B12opt 0:84182. The latter value is a maximum achievable total producers and consumers surplus. Now let us consider the market equilibrium. The regulation of market in the considered model reduces to the choice of price cap pmax. Fig. 3 shows the pmax dependences of capacities, average electricity undersupply dQ QD Q=Q and losses of the total producers and consumers surplus dB12 1 B12 =B12opt . It is seen that the price cap affects essentially the capacity of power plants on fossil fuel that serve as peak power sources in the system. Giving a relevant value of pmax we can create an incentive for investors to commission new power plants in such a manner that the capacity QmF may turn out both lower and higher than the optimal. The capacity of RES QmR in a wide range of change in pmax remains approximately constant. With rising pmax the electricity undersupply dQ monotonously decreases and the losses dB12 reach the minimum (maximum of total producers and consumers surplus B12 ) at the price cap pmaxE2 US$/kWh. Deviation to a lesser value (underinvestment, damage from electricity undersupply) increases the economic losses sharply whereas the deviation to a larger value (overinvestment, extra costs of producers) increases them gradually. At the price cap pmax 2 US$/kWh the capacities of power plants (QmF and QmR) exceed the optimal values approximately by 1%, and the losses of total producers and consumers surplus dB12 make up 0.004%, i.e. a very low value. Taking into account that in the market organization of the electric power industry there are additional factors (economic incentives for producers and consumers to decrease costs) that are not considered in the model, we can conclude that even at non-elastic short-term demand and sharp uctuations of prices (that take the values 0, 0.02 and 2 US$/kWh) the market in

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(a)

(b)

(c)

(d)

Fig. 3. Power plants capacities (a), electricity undersupply (b) and the losses of total producers and consumers surplus (c, d) versus price cap.

principle can provide almost optimal structure of generating capacities and high economic efciency of electricity production and consumption. In all the above options, electricity consumption q and average electricity price p did not depend on pmax and remained constant (q 1.146 and p 0:156 US$/kWh). This can be explained by the fact that at any price cap, the capacity of power plants is determined by investors on the basis of the investment payback; therefore the average price remains constant, equal to the marginal long-term costs of electricity production [14,15]. The calculations performed show that large uctuations of electricity prices in the market are an inevitable and normal phenomenon. An effort of the regulating bodies to protect consumers by tightening the regulations (by establishing the price cap pmax below its optimal value) will result in a narrower range of price uctuations but the high price periods will occur more often, so the average price will still remain constant and the economic efciency of the resources allocation will decrease. 5. Internalization of external costs The environmental damage caused by electric power industry to nature and public health depends (along with the other factors) on the amount of fossil fuel consumed. Linearizing this dependence and adding the estimated costs of the environmental damage to the objective function B12 , instead of condition (8), we get BS B12 v QF ! max , (80 )

where v* is a specic environmental cost. The objective function BS takes into account the interests of electricity producers, consumers and society as a whole.

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1.2 Q mR 1.1

1.0 B 0.9 Q mF, q 0.8 0 5 10 v* , cent/kWh 15 20

Fig. 4. Dependences of optimal values of power plant capacities QmF and QmR, electricity consumption q and maximum value of the social welfare criterion BS on specic environmental cost v* (with respect to variant v* 0). Dependences of QmF (v*) and q(v*) practically coincide.

Fig. 4 shows the solution to the optimization problem (8) depending on v*. As was to be expected with a growing specic environmental cost, it is expedient to decrease the installed capacity of power plants on fossil fuel, increase the RES capacity and reduce power consumption (introduce energy-saving measures). Since the criteria of the market participants (producers and consumers) do not depend on the environmental cost, the value v* does not affect the market equilibrium. With pmax 2 US$/kWh and v* 0.2 US$/kWh this leads to a decrease of the objective function BS as compared to its maximum possible value by 2.4%, which is essentially higher than the decrease in the total producers and consumers surplus B12 due to nonelasticity of the short-term demand. To shift the market equilibrium in the required direction, we can use the mechanisms of target taxes and subsidies (established on a centralized basis) for the electricity market participants, for example:

  

an environmental tax (the tax on harmful substance emissions, including greenhouse gases) from energy sources on fossil fuel (in the model it can be taken into account by an increase in the fuel price, i.e. variable costs DvF); subsidies to investors that commission RES (a decrease of constant costs by DcR) and an electricity consumption taxan additional rise in price Dp. Then the Eqs. (1), (2) and (4) take the form B1F pQF vQF cF QmF DvF QF 0, B1R pQR cR QmR DcR QmR 0, q=q0 p Dp=p0 b . (10 ) (20 ) (40 )

The criterion of social welfare (80 ) remains unchanged, since the taxes and subsidies only reallocate the funds among the subjects of a single economic system.

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1.2 1.1 1.0 1.0 0.9 0.8 0 5 QmR QmF 0.8 10 15 vF, cent/kWh 20 25 0.0 1.2 Q mR Q mF, q q

987

(a)

(b)

0.5 cR, cent/kWh

1.0

1.2

Q mF, q

1.0 Q mR 0.8 0 5 10 p, cent/kWh 15

(c)

Fig. 5. Dependences of power plants capacities QmF and QmR and electricity consumption q on the tax on emissions DvF (a), subsidies to RES DcR (b) and the consumption tax Dp (c) at pmax 2 US$/kWh and v* 0.2 US$/kWh (with respect to the optimal solution).

Fig. 5 presents the market equilibrium calculated using each of the above mechanisms separately. The environmental tax (the tax on emissions) stimulates the decrease in capacity of power plants on fossil fuel and reduction of electricity consumption; however, imposition of the tax does not increase but decrease the RES power. As a result at the optimal value DvFE0.15 US$/kWh, the social welfare criterion (80 ) is 1.3% lower than its maximum possible value (at the optimal solution). The subsidies to RES lead to a growth of their capacity; however, at the same time the capacities of power plants on fossil fuel and electricity consumption increase (but do not decrease as it is required to near the optimum). At the optimal value DcRE0.05 US$/kWh the value BS is 2.1% lower than the maximum possible. The consumption tax works almost similarly to the environmental tax (QmF, q and QmR decrease). At DpE0.10 US$/kWh the social welfare criterion BS is 0.9% lower than the maximum value. Thus, of the three considered mechanisms (if they are applied separately), the most efcient is the consumption tax and the least efcient is subsidies to RES. The described mathematical model allows the estimation of the efciency of the green certicate trade mechanism used in a number of countries [1113]. This mechanism suggests that all the electricity consumers be obliged to buy a certain share of electricity generated by renewable energy technologies. Renewable energy technologies will get a green certicate, which can be sold to distribution companies or other electricity

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consumers with the obligation to cover a certain share of their electricity consumption with green power. Not considering in detail this market we can describe approximately the purchase of the certicates by electricity consumers as their additional expenses DpNq, and selling the certicatesas subsidies to RES DcRQmR. Equating these sums, we have the condition Dp DcR QmR =Nq. (9)

Fig. 6 shows the results of calculating the values QmF, QmR and q depending on DcR, (concurrently with DcR the value Dp also changed in accordance with the relationship (9); the values QmR and q in (9) were determined from the optimization problem at v* 0.2 US$/kWh). Comparison of Figs. 6 and 5b shows that such a mechanism improves the market characteristics as compared to the option with only subsidies to RES (QmF and q do not increase but somewhat decrease). However, such a method of market arrangement is also not ideal and does not allow the maximum social welfare criterion (the deviation is 1.2%) to be reached. The reasons are: rstly, the green certicate market does not give sufcient incentives to power plants on fossil fuel to decrease electricity production; secondly, the market efciency decreases due to the need to provide the balance between the funds (collected from consumers and received by the RES owners). The calculations show that the consumption tax should be higher than the subsidies required to RES for their optimal expansion. This is in agreement with the results obtained in [15], showing that at non-elastic short-term demand even without environmental damage there is a need for consumption tax to increase the efciency of the system producers+consumers. The funds collected in this way do not come to producers and may, for example, be returned to consumers as a compensation for the damage related to the power supply limitations. Using the market arrangement mechanism that makes it possible to simultaneously vary the parameters DvF, DcR and Dp, we can completely exclude the market efciency losses as

Q mF, q 1.2

1.0 Q mR

0.8 0.0 0.5 cR, cent/kWh 1.0

Fig. 6. Dependences of power plants capacities QmF and QmR and electricity consumption q on subsidies to RES DcR (formed on the basis of the consumption tax Dp) at pmax 2 US$/kWh and v* 0.2 US$/kWh (with respect to the optimal solution).

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O.V. Marchenko / Renewable Energy 32 (2007) 976990 989 Table 1 Dependence of the optimal values of the tax on emissions DvF, subsidies to RES DcR and the consumption tax Dp on the specic environmental cost v* (all the values are in cents/kWh; pmax 2 US$/kWh) v* 0 5 10 15 20 DvF 0.29 0.36 0.37 0.44 0.56 DcR 0 0.40 0.67 0.86 1.00 Dp 0.36 3.53 6.41 9.05 11.51

compared to the optimal solution. Set the values QmF, QmR and q equal to their optimal values (Fig. 4) and nd the corresponding values DvF, DcR and Dp from the system of market equilibrium Eqs. (10 ), (20 ), (40 ) and (5)(7). The results of the calculations are presented in Table 1. With such values of taxes and subsidies, the market participants maximizing their own economic surpluses provide the optimal (from the social viewpoint) mix of conventional and renewable energy sources and maximum social welfare criterion taking into account the environmental impact of electric power industry on the environment. 6. Conclusion A mathematical model of a long-term (considering the expansion of generating capacities) equilibrium in the electricity market with conventional energy sources on fossil fuel and non-conventional renewable energy sources (RESs) with stochastic operating conditions has been developed. It has been shown that at an optimal choice of the price cap the variability of load and RES output, non-elasticity of the short-term demand and sharp price uctuations do not prevent the competitive market from keeping the high economic efciency of electricity production and consumption processes. However, such an arrangement is not sufcient to take into account the external effects, i.e. environmental costs that are met by the other subjects rather than by the market participants. To increase the efciency of the electric power industry, the market should foresee the mechanisms that convert the external effects into the economic indices of the market participants and encourage them to act in the interests of the society. The mechanisms considered as such were the environmental tax (the tax on emissions of harmful substances by energy sources on fossil fuel), subsidies to RES and the consumption tax. It is shown that the simultaneously established values of the taxes and subsidies encourage the market participants to nd the optimal (from the societys viewpoint) mix of conventional and renewable energy sources. Here the market mechanism provides maximum economic efciency of the electric power industry taking into account the environmental factor. Acknowledgment The work was performed with the support of the Russian Humanitarian Scientic Fund (project code 06-02-00266a).

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