What explain the short-term dynamics of the prices of CO2 emissions?

Abstract

Using a Bayesian Structural VAR (BSVAR), this paper analyzes the short-term dynamics of the prices of CO2 emissions in response to changes in the prices of oil, coal, natural gas and electricity. The results show that: (i) a positive shock to the crude oil prices has an initial positive effect on the CO2 allowance prices, which later becomes negative; (ii) an unexpected increase in the natural gas prices reduces the price of CO2 emissions; (iii) a positive shock to the prices of the fuel of choice, coal, has virtually no significant impact on the CO2 prices; (iv) there is a clear positive effect of the coal prices on the CO2 allowance prices when the electricity prices are excluded from the BSVAR system; and (v) a positive shock to the electricity prices has a negative impact on the price of the CO2 allowances. We also find that the energy price shocks have a persistent impact on the CO2 allowance prices, with the largest effect occurring 6 months after a shock strikes. The effect is particularly strong in the case of the shocks to the natural gas and crude oil prices. Finally, the empirical findings suggest an important degree of substitution between the three primary sources of energy (i.e., crude oil, natural gas and coal), particularly when electricity prices are excluded from the BSVAR system.