An analysis of the interactions between electricity, fossil fuel and carbon market prices in Guangdong, China

Abstract

Using the available information and a standard econometric approach analyzing the time series dataset, this study identifies the interactions between electricity, fossil fuel and carbon market prices in Guangdong, China. The result confirms a long running co-integration between carbon market prices and the prices of coal, diesel and liquid natural gas (LNG). Conversely, fossil fuel prices have no impact on the short term dynamics of carbon prices. The price of electricity on the monthly forward market in Guangdong is significantly and positively associated with the first difference of the price of coal, but has no significant relationship with the first differences of carbon, diesel and LNG prices. This analysis provides certain implications for ongoing power sector reform and nationwide carbon market development in China. The liberalization of the power industry should be further advanced to create conditions for carbon cost pass-through on to the electricity market. Meanwhile, the national emissions trading scheme (ETS) should apply simpler and stricter benchmarks to allocate emissions allowances for the power sector. Fewer categories of benchmarks promote competition among different types of power generators and a shift to an electricity supply portfolio with lower carbon intensity. Stricter benchmarks create more demand for emissions allowances and result in higher carbon market prices. To increase the ratio of emissions allowances by auctioning is also necessary to put substantial pressure on thermal power plants to pass their carbon costs on to end users.