A three-step procedure to investigate the convergence of electricity and natural gas prices in the European Union

Abstract

The paper introduces an innovative three-step approach to simultaneously investigate the price dispersion in retail electricity and natural gas markets for both domestic and industrial consumers over time and across EU countries. In the first step, a multilateral Country-Product-Dummy price index is applied to estimate the purchasing power parity (PPP) of the EU energy market. In the second step, the PPP values are then used to cluster the EU countries by means of a hierarchical cluster analysis based on the Ward method. Finally, in the third step, the Hodrick-Prescott filter is employed to estimate the PPP trends and to investigate different notions of convergence, within and between the identified clusters. We show that different EU countries can be classified into four clusters which are characterized by CPD indexes and PPPs below, slightly below, slightly above and above the average CPD/PPP series, respectively. Taken together, the results from our analysis indicate that the electricity and natural gas prices across the EU-28 member states have not converged, despite significant efforts in market integration and regulatory harmonization. The evidence of a slow beta-convergence is not associated with sigma- and club convergence both at intra- and inter-cluster level. Among country-specific factors, the results suggest that the adoption of national energy and climate policies could have played a major role in explaining the difficulties of the convergence process at a retail price level.