Pass-through of emissions costs to electricity prices

No Thumbnail Available
Journal Title
Journal ISSN
Volume Title
School of Business | Master's thesis
Degree programme
This research paper examines the pass-through of CO2 emissions cost to the wholesale electricity price in Portugal and Spain for years 2010 to 2018. Pass-through rate tells us how much the price of the output changes as a result of tax on the input. Cost pass-through has implications to the welfare of the consumer and the producer as it determines which party bears the cost of the emission. I employ reduced form estimation to estimate the pass-through rate. The price of the European Union emission allowance is utilized in order to estimate marginal emissions costs, whereas the price of electricity is an equilibrium result of bidding by the electricity generators and operators in Portugal and Spain. A rich dataset of 72,000 observations is collected from electricity market operators, stock markets and weather stations. The data is collected and analyzed by hourly basis as the electricity demand in the market varies significantly depending on the time of the day. Finally, fixed effects are employed to account for seasonality and trends. I alternatively replace fossil fuel prices in my estimation with marginal costs to understand the flaws in the model better. There are no studies conducted on the Iberian electricity markets that estimate the pass-through of emissions cost after 2007. Therefore, my study provides an interesting look on the pass-through rate for more recent years. Additionally, I obtain estimates of pass-through rates for the most recent European Union Emission Trading System phase, which makes them more relevant today than older results. Previous studies suggest that the pass-through rate in the electricity markets across countries is near to complete, which implies that the consumers bear the burden of cap and trade in electricity markets. The results obtained in this research paper are in line with the pass through rate estimates found in previous studies. The pass-through estimates vary from 84% to 87% depending on the specifications. I also find that the pass-through rate is higher during peak-hours than it is during off-peak-hours. This is consistent with the assumption that companies bid below their marginal costs during periods of low demand. By examining the pass-through rates on annual basis, I find evidence of possible reciprocity between electricity price, emissions cost and fuel prices. This may render our estimates as well as those from other authors biased. Problems arising from this multicollinearity are not studied in the pass-through literature to a great extent, which makes some of the results questionable.
Thesis advisor
Liski, Matti
Vehviläinen, Iivo
ETS, emissions cost, pass-through rate, electricity markets, MIBEL, Spain, Portugal
Other note