European Electricity Prices and the EU Emissions Trading System

Lessons from the UK Carbon Price Floor

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Efficient regulation is required in order to reduce carbon emissions and achieve the goals of the Paris Agreement. The EU ETS is currently the most important regulatory instrument implemented for this purpose. Although the effects in terms of abatement are certain, the EU Emissions Trading System (ETS) introduces uncertainty with regard to the price of carbon emissions. Carbon price levels have dropped significantly in the wake of the 2008 financial crisis. ARX-GARCHX models have been employed to fit hourly day-ahead prices in nine European countries and fit daily average wholesale electricity prices in the UK using dummy variables for the introduction of the UK Carbon Price Floor (CPF). In the former analysis it is found that carbon prices were only passed through to electricity prices after carbon prices increased in 2018. In the UK it was found that the carbon to electricity price pass-through was present only after introduction of the CPF, even though permit prices remained low. Therefore, it is concluded that the total costs of emitting should exceed a certain threshold value for the price of carbon to be passed through to electricity prices. This thesis proposes a dynamic CPF design that can be introduced EU-wide or on a national level. The introduction of such a price stability mechanism would ensure the carbon price pass-through needed to achieve long-term environmental goals, regardless of developments in the carbon market.