Carbon Pricing and Renewable Investment Incentives: A Study of the Italian Electricity Market

The electricity sector is one of the largest contributors to greenhouse gas emissions, making its decarbonization crucial for achieving a net-zero economy. Carbon pricing is generally regarded as a key market-friendly instrument for decarbonizing the power sector, based on the premise that it discourages investment in fossil-fuel-based technologies. This paper revisits this conventional view by developing an hourly simulation model of the Italian electricity market to assess whether this mechanism operates as expected in practice. Our results show that carbon pricing may generate unintended investment incentives. Under certain conditions, particularly when the pass-through of carbon costs to electricity prices is sufficiently high, higher carbon prices can increase the relative profitability of gas-fired generation compared with renewable technologies. This unintended effect disappears when pass-through is limited or when carbon pricing is combined with green investment subsidies, highlighting the complementarity between these policy instruments. Overall, the findings show that the effectiveness of carbon pricing depends critically on market-specific characteristics and that an appropriate policy mix may be required to prevent unintended consequences and reduce the risk of policy failure.