Contracts and constraints: how long-term power purchase agreements undermine carbon pricing in India’s electricity sector

Market-based instruments like carbon pricing are increasingly being adopted in developing countries to mitigate carbon emissions. However, institutional features such as long-term electricity contracts and regulated tariffs may mute their effectiveness. I explore this question in the context of the electric power sector in India, where electricity is transacted primarily via long-term bilateral contracts and state-owned distribution utilities self-schedule contracted power plants to meet their demand. The absence of a centralized and dynamic market-based economic dispatch mechanism generates short-run misallocation in electricity dispatch and distorts long-run investment decisions, such as the incentive to invest in flexible generation capacity and energy storage to complement renewable-based capacity. Using panel data on coal price schedules and monthly plant-level operations from 2012 to 2020, I construct a predicted delivered coal price index to estimate the elasticity of plant utilization with respect to fuel prices. I find that the demand for electricity from coal-fired power plants with a higher share of capacity allocated under long-term bilateral contract(s) is less sensitive to changes in coal prices, implying that the existing market design could erode some of the environmental benefits of carbon pricing.