Has the EU-ETS Financed the Energy Transition of the Italian Power System?

Abstract

This paper focuses on the relationship between the European Union Emission Trading System allowances’ prices and the Italian electricity price, aiming at assessing whether such a mechanism has been a driver for the decarbonization of the power sector. To this aim, we calculate the long-run relationships between energy prices, natural gas prices and allowances’ prices, through a VECM model, distinguishing between peak and off-peak prices. The analysis is carried out for the third phase of the EU-ETS, which started in 2013, and for two-year rolling windows that account for changes over time of the pass-through rates. It is shown that the natural gas price has a high pass-through rate of roughly 70%, which is increasing over time. On the contrary, the pass-through rate of the allowances’ price is as low as 7% for the wholesale electricity price, being slightly more and less for the peak and off-peak prices, respectively. However, this rate has been substantially changing over time, starting from a high level and falling significantly, becoming negative in the recent years. This could signal that the EU-ETS has been increasingly more effective in endogenizing emission costs for power producers, inducing them to reduce their production costs associated with emissions by means of a change in technologies. However, the analysis of the impulse response functions hardly supports this finding, eventually casting doubts on the effectiveness of the EU-ETS in Italy to drive the transition toward a less carbon-intensive power supply.

Impacts of Carbon Emission Trading Markets on Energy Transformation: A Review of the Existing Literature

“…When exploring the relationship between the carbon market and the energy generation industry, it is also necessary to consider the relationship between carbon prices and electricity prices. Koch et al (2013) argue that electricity prices have a positive impact on carbon prices, while Caporin et al (2021) found in their study of the Italian carbon market that an increase in 1 euro carbon price is accompanied by an increase in 7 euro cents electricity prices. However, research has shown that there is no strong causal relationship between carbon prices and electricity prices.…”

“…The implementation of carbon emission trading markets will invisibly increase the energy costs of carbon emissions, not only affecting the production costs of industrial producers, but also guiding consumers to make rational choices and stimulating the demand for low-carbon energy. Therefore, there is a two-way linkage relationship between the carbon market and the energy market (Caporin et al, 2021;Hammoudeh et al, 2014). This is also the "linkage effect" theory proposed by Hirschman (1958), where the impact of fossil energy prices on carbon prices can be divided into two paths: income effect and substitution effect.…”

The Energy Transition and the Value of Capacity Remuneration Mechanisms

“…There exist a large literature on the estimate of electricity costs pass-through, that we cannot review here. See for instanceCaporin et al (2021) and references therein.13 Similarly, we do not consider the lag-time that usually exists between the awarding of the premium and the effective delivery of capacity, and similarly assume that new investments occur instantaneously.…”