Markets for Carbon and Power Pricing in Europe: Theoretical Issues and Empirical Analyses

Citation

Bhattcharyya, S. (2010), "Markets for Carbon and Power Pricing in Europe: Theoretical Issues and Empirical Analyses", International Journal of Energy Sector Management, Vol. 4 No. 3, pp. 486-488. https://doi.org/10.1108/17506221011073860

The European emissions trading system (EU‐ETS) that came into existence in 2005 is one of the main instruments being used in the European Union to limit greenhouse gas emission emissions. The power sector, being one of the main contributors to carbon‐dioxide (CO₂) emissions, is a major target industry under the EU‐ETS. The participants in the EU‐ETS have received certain amounts of tradable permits free of charge subject to a pan‐European cap set by the European Commission. Each participant is required to surrender permits equivalent to their annual volume of emissions and can trade the balance, if any. This mechanism was expected to create a market for carbon that would determine the carbon price through a competitive process. However, it was observed that some participating electric utilities have managed to increase their profits, implying some sort of emissions trading windfall gain for them. This caught the attention of some regulators and caused concerns about the exploitation of consumers because of the free allocation of permits and the possibility of exploitation of consumers through cost pass through in retail/wholesale prices. This book is devoted to this specific and specialized issue and tries to explain such concerns through analytical and empirical studies.

The book contains nine chapters divided into two parts – one dealing with theoretical aspects and the other focusing on the empirical analysis. The introductory chapter by the editor (Francesco Gulli) sets the research questions and presents an overview of the book. This highlights the limitations of the analyses and the lack of any consensus on the outcomes. Chapter 2 Liliya Chernyavs'ka introduces the legal background of the EU‐ETS and presents early results, and the future outlook. This chapter provides a good overview of the system and is highly accessible. Chapter 3 the editor examines the effects of emissions trading on electricity prices in the short‐run using a two‐ technology‐based simplified model in an auction‐based wholesale power market. This analytical study mainly tries to find out whether the impact of trading varies with different market structures or not. It finds that a competitive market fully internalises the carbon cost while the outcome under imperfect competition depends on the market power, plant mix and the existence of excess capacity in the system or not. Although the model used is a simplified one, the analysis is not accessible to general readers without specific knowledge in the subject. In Chapter 4, Julia Reinaud explains how ETS affects the industrial consumers of electricity through an analysis of the contractual arrangements.

This is a descriptive chapter and it is not clear how it fits in the theoretical analysis of the book as there is hardly any theoretical stuff in the chapter.

The second part contains five chapters. The first chapter of this part, Chapter 5 by Sijm et al. clearly presents the concerns related to ETS‐induced effects on electricity prices. This chapter also provides the estimates of average pass‐through rates in Germany and the Netherlands and discusses the policy implications for the results. In fact, readers have to wait until this chapter to find out the main issues and the concerns. This chapter could have been moved to the theoretical part of the book to enhance the reading experience. Chapter 6 by Derek Bunn and Carlo Fezzi use a co‐integrated vector auto‐regression model to analyse how gas and carbon prices influence electricity prices in Germany and in the UK. Chapter 7 presents another case study – the effects of ETS on the Finnish power sector. The authors present the theoretical expectation of the effect of emissions trading on the Nordic electricity markets and then use two alternative models to find the effect empirically. The theoretical part is simple but useful and could have been moved to the first part of the book. But the editor himself explains that “the econometric models are very useful for providing a precise (statistically significant) value of the carbon pass‐through but they are not able to justify this value […] ” (p. 7). Therefore, a non‐econometric empirical analysis is presented in Chapter 8. The authors use the load duration curve approach to analyse the pass‐through rates hour‐by‐hour for Italy. This approach can also take into account structural factors that are not considered in the econometric models. But this approach only provides a range of variability of pass‐through rates and does not provide a precise value as can be obtained in the econometric method. The last chapter considers the interaction between renewable energy promoting policies and the carbon markets. This uses Spain as a case study and uses a generation expansion model to analyse the effect.

Clearly, the book analyses an important, contemporary issue and makes a valuable contribution to the knowledge. However, with some additional care the quality of the book could have been improved and its accessibility enhanced. The theoretical part does not really do justice to the task and could have been improved by some rewriting and adjustments in the chapters. Although the empirical chapters use modern methods of analysis, the limitations in the methods (essentially an extrapolation of the past behaviour and limited use of driver variables as is common in such approaches) reduce their explanatory power. Also, the wide variations in the results make such analyses poorly suited to any policy‐oriented works. A concluding chapter with a policy analysis would have been appropriate as well.

Despite such limitations, the book will appeal serious academic researchers and those planning doctoral studies in the area.