The economic theory suggests that external costs can serious influence the level of social welfare. A typical example where such negative effects exist is energy sector, which produces large amounts of emissions. As recent works demonstrate the welfare economics is a fundamental framework that enable to invent and implement efficient tools and solutions to maintain the sustainable development. Inclusion of external costs in the decision-making process seems to be a crucial point to achieve a social optimum. On the basis of the partial equilibrium model a development of domestic energy sector was analyzed. The results considered in the light of the two main criteria that formulate the condition of effective allocation of resources. The first criterion assumes the cost-effective allocation, which means a cost minimization principle to achieve a specific environmental objective – the desired emissions level. The second criterion is based on maximization of social welfare that is defined as a sum of producers’ and consumers’ surplus. It was showed that the type of criterion used in the calculations has a significant influence on the results. It was proved that traditional approach, based on minimization of production costs, does not give socially optimal solution. Only a full internalization of external costs in the price decisions of energy producers can bring a social welfare improvement.