Discussion Paper

EU-ETS and Nordic Electricity: A CVAR Analysis

Aug 15, 2008 | Harrison Fell

Abstract

A cointegrated vector autoregressive (CVAR) model is estimated to determine the dynamic relationship between Nordic wholesale electricity prices and EU emissions trading scheme (EU-ETS)CO2 allowance prices. An impulse response analysis reveals that electricity prices have large short-term responses to CO2 price shocks, but that this response dampens over time. Using hourly Nordic electricity spot market prices, I find that the value of short-term response of electricity prices to a shock in CO2prices in off-peak hours is consistent with expected values for near complete pass-through of CO2 emission costs when coal-generated power is at the margin. Likewise, the estimates reveal that peak hourelectricity price responses to CO2 price shocks are as expected for a market that has near complete passthrough of CO2 emission costs when natural gas-generated power is at the margin. These results further suggest the Nordic electricity market is pricing as a competitive market.