Cointegration Analysis of the Convergence Process in the European Electricity Markets

Abstract

This paper investigates the degree of integration among markets using wholesale electricity prices. The reason arises from the link between the long-run dynamic of fuel prices and electricity prices. We address the question of whether European electricity markets have experienced convergence patterns in the last years using the stochastic definitions of convergence and common trend based on co-integration analysis. We apply a Vector Error Correction model to a representative sample of electricity spot prices of European markets, including those of Italy, France, the Netherlands, Poland, and the integrated market of Germany and Austria. We analyze both the long- and the short-run of system properties, studying their persistence profiles. The short-run analysis reveals the non–significance of adjustment coefficients of the market prices in the Netherlands and Poland. Moreover, the Netherlands Granger causes Poland and the integrated market German and Austria, but the reverse is not true. A unidirectional Granger causality has been found also for France and Germany and Austria toward Italy. Given the cointegrating equilibrium, all country-specific price dynamics converge toward the steady state, but most of the exogenous shocks have permanent effects. Forecast Error Variance Decomposition analysis clearly highlights that orthogonalized shocks largely affect the variance of neighboring markets.