Markets for Carbon and Power Pricing in Europe
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Markets for Carbon and Power Pricing in Europe

Theoretical Issues and Empirical Analyses

Edited by Francesco Gullì

Why do power prices seem to be correlated with the carbon price in some markets and not in others? This crucial question is at the centre of Francesco Gullì’s enlightening book, through which the contributing authors investigate a number of related issues. In particular, they explore why power firms are not consistent in passing-through into power prices the opportunity cost of carbon. They also examine the relationship between the pass-through mechanism and the structure of the power market.
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Chapter 3: Modelling the Short-run Impact of ‘Carbon Trading’ on the Electricity Sector

Francesco Gullì


Francesco Gullì INTRODUCTION 3.1 This chapter studies the impact of ‘carbon emissions trading’ (trading of CO2 emissions allowances) on the electricity sector, focusing on the European Emission Trading Scheme (EU ETS). Started in 2005, the EU ETS1 covers several sectors of which power generation is the largest one. Therefore, on the one hand, the performance of the trading scheme largely depends on its ability to induce the power industry to reduce CO2 emissions significantly in the short and long runs. On the other hand, it might have a considerable impact on consumers’ surplus and firms’ profits and competitiveness. Either the performance of the EU ETS or its impact on social welfare depends on how and to what extent the CO2 price is passed through into power prices. This study focuses on this latter issue, attempting to provide a better understanding of how a CO2 price could impact on electricity pricing2 and carbon emissions. The economic literature on emissions trading is extensive and covers several fields.3 However, existing studies have mainly been concerned with design issues rather than with the impact on correlated (product) markets. With regard to the electricity sector, only recently has a specific research effort been made to study the effects of the ETS on product prices, but studies generally assume purely competitive frameworks which are far from the reality of electricity markets. These, in fact, are more or less concentrated markets where one or more firms are able to exercise market power....

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