A novel annual and daily planning for integrated carbon and electricity markets based on fuel tax

A reliable and sustainable energy supply is increasingly essential as energy demand rises due to population growth, economic development, and improved living standards. However, fossil fuel-based electricity generation significantly contributes to CO₂ emissions, posing challenges to human well-being. This paper proposes a sequential annual-daily planning framework for an integrated carbon market (CM) and electricity market (EM) system incorporating a fuel tax . The system operates at three primary levels: annual planning, daily CM execution, and daily EM execution. At the annual planning stage, initial allocations and pricing of carbon allowances are determined, along with the calculation of each plant's allowance share and the setting of a fuel tax, which is embedded into plants' cost functions. During daily CM execution, an initial forecast of the next day’s electricity price is made. The profit maximization problem for plants is analyzed at different carbon price levels, and bidding curves are constructed to clear the CM. Following this, the EM is executed, where profit maximization at different electricity price levels is solved, and the energy bidding process determines the EM clearing point and price. Any plant allowance shortages or surpluses are balanced by transferring allowances to future periods. By coordinating the CM and EM through an innovative fuel tax mechanism, this integrated framework aims to provide efficient price signals and incentives for reducing carbon emissions in the power sector. This paper provides a detailed overview of the structure and operation of this combined market mechanism, highlighting its potential to provide coordinated operational incentives for emission reduction under the adopted market assumptions. Simulation results show that introducing a fuel tax increases the average carbon price from $11.8/ton to $17.9/ton, leading to a 115% rise in renewable generation and a 373.7% increase in renewable plant profits. Fossil-fuel plant profits also rise by 239% due to elevated electricity prices, while total system-wide profits increase by 271%. Furthermore, annual CO₂ emissions decrease significantly over time. The stylized case study indicates that strategic design and allocation of market parameters play a critical role in shaping market behavior, price dynamics, and profitability across different generation types.