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EU-ETS and Nordic Electricity: A CVAR Analysis

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 CO2 prices 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 hour electricity price responses to CO2 price shocks are as expected for a market that has near complete pass-through 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.

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Energy Specializations: Electricity – Markets and Prices ; Electricity – Policy and Regulation; Energy and the Environment – Climate Change and Greenhouse Gases; Energy and the Environment – Policy and Regulation

JEL Codes:
D42 - Market Structure, Pricing, and Design: Monopoly
E60 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook: General
Q54 - Climate; Natural Disasters and Their Management; Global Warming

Keywords: EU-ETS, Nordic electricity, CVAR model, CO2 emissions

DOI: 10.5547/ISSN0195-6574-EJ-Vol31-No2-1

Published in Volume 31, Number 2 of The Quarterly Journal of the IAEE's Energy Economics Education Foundation.