Time Variation in European Carbon Pass-Through Rates in Electricity Futures Prices

Abstract

The European Union Trading Scheme (EU ETS) gives emission allowances a market price and are a marginal cost factor for those power plants that run on polluting fuels. Power plants have these costs in mind when they determine the selling price of their output. Being sold on a market place, it makes sense to expect that electricity market prices somehow reflect the price of emission rights. The pass-through rate measures the fraction of the price of an emission right passed through to the electricity market price.It is often assumed that the pass-through rate of emission costs in electricity prices is constant within a specific time period. We argue that this is unlikely as electricity is produced by suppliers that apply different emission intensive technologies. Depending on different demand levels between and over days, we expect that the pass-through rate should vary and not be constant as the market clearing price is determined by different marginal producers who differ in terms of emissions intensity. We therefore test the hypothesis that pass-through rates are constant and we find strong support, using futures prices from the U.K. and Germany, for rejecting this hypothesis against the alternative that pass-through rates are non-constant and vary over time.