An electricity market-based approach to finance environmental flow restoration

As environmental flow demands become better characterized, improved water allocation and reservoir operating solutions can be devised to meet them. However, significant economic trade-offs are still expected, especially in hydropower-dominated basins. This study explores the use of the electricity market as both an institutional arrangement and an alternative financing source to handle the costs of implementing environmental flows in river systems managed for hydropower benefits. A framework is proposed to identify hydropower plants with sustainable operation within the portfolio of power sources, including a cost-sharing mechanism based on the electricity market trading to manage a time-step compensation fund. The objective is to address a common limitation in the implementation of environmental flows by reducing the dependence on government funding and the necessity for new arrangements. Compensation amounts can vary depending on ecosystem restoration goals (level of flow regime restoration), hydrological conditions, and hydropower sites characteristics. The application in the Paraná River Basin, Brazil, shows basin-wide compensation requirements ranging from zero in favorable hydrological years to thousands of dollars per gigawatt-hour generated in others. Each electricity consumer's contribution to the compensation fund is determined by their share of energy consumption, resulting in values ranging from cents for residential users to thousands of dollars for industrial facilities. Finally, the compensation fund signals the economic value of externalities in energy production. For residential users, achieving varying levels of ecosystem restoration led to an electricity bill increase of less than 1 %. For larger companies, the increase ranged from less than 1 %-12 %.