Title: Evaluation of dynamic pass-through of carbon prices into electricity prices - a cointegrated VECM analysis

Authors: Carlos J. Pereira Freitas; Patrícia Pereira Da Silva

Addresses: Institute of Engineering, Polytechnic of Porto (ISEP), Rua Dr. António Bernardino de Almeida, 431, 4200-072 Porto, Portugal; Faculty of Economics, University of Coimbra, Av. Dias da Silva, 165, 3004-512 Coimbra, Portugal ' Faculty of Economics, University of Coimbra, Av. Dias da Silva, 165, 3004-512 Coimbra, Portugal; INESC Coimbra, Rua Antero de Quental, 199, 3030-030 Coimbra, Portugal

Abstract: This paper addresses the impact of the CO₂ opportunity cost on the wholesale electricity price in the context of the Iberian electricity market (MIBEL), namely on the Portuguese system, for the period corresponding to the Phase II of the European Union Emission Trading Scheme (EU ETS). In the econometric analysis a vector error correction model (VECM) is specified to estimate both long-run equilibrium relations and short-run interactions between the electricity price and the fuel (natural gas and coal) and carbon prices. The model is estimated using daily spot market prices and the four commodities prices are jointly modelled as endogenous variables. Moreover, a set of exogenous variables is incorporated in order to account for the electricity demand conditions (temperature) and the electricity generation mix (quantity of electricity traded according the technology used). The outcomes for the Portuguese electricity system suggest that the dynamic pass-through of carbon prices into electricity prices is strongly significant and a long-run elasticity was estimated (equilibrium relation) that is aligned with studies that have been conducted for other markets.

Keywords: European Union Emission Trading Scheme; EU ETS; Iberian electricity market; cointegration; vector error correction model; VECM; European climate policy; Kyoto Protocol; carbon cost pass-through; climate change; CO2; carbon dioxide; carbon trading; opportunity costs; wholesale electricity prices; Portugal; fuel prices; natural gas prices; coal prices; carbon prices; modelling; electricity demand conditions; electricity generation mix.

DOI: 10.1504/IJPP.2013.053440

International Journal of Public Policy, 2013 Vol.9 No.1/2, pp.65 - 85

Published online: 31 Jan 2014 *

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