The impact of sector coupling on climate policy regulations

Deep decarbonization requires electrification of energy-related processes across all sectors of the economy. This so-called sector coupling has important implications for quantity-based regulations in the electricity sector which overlap with measures that promote electricity-based technologies in other sectors, like subsidies for electric vehicles, CO2 taxes on fossil technologies, or a separate ETS in the transport and buildings sectors. We show this for emissions trading systems (ETS) and renewable portfolio standards (RPS). The switch to electricity-based technologies usually strengthens an existing RPS. For the EU ETS, the switch raises demand for emission allowances in countries with such additional policies, but emission reductions come from all countries within the ETS. There is thus a reverse waterbed effect. Numerical simulations for overlapping regulations in the EU and the US underpin the policy relevance. They suggest that overlapping policies should generally target sectors not covered by quantity instruments such as an ETS or RPS.