Pass-through of CO₂ Emission Costs to Hourly Electricity Prices in Germany

Abstract

I estimate the level of emissions cost pass-through to hourly wholesale electricity prices in Germany, based on spot market data. I control for contemporaneous shocks to demand and supply by constructing a detailed supply curve for fossil generation, and intersecting it with residual demand for fossil-based electricity for every hour. Determining the marginal generator allows me to use marginal fuel and carbon costs (rather than prices) as explanatory variables in order to identify the level of cost pass-through directly and with a high level of precision. I find that carbon costs are passed through to electricity prices by at least 84%, with a central range of 98%-104% for different load periods. My results suggest that there is no economic reason for free allowance allocation to the electricity sector, and thus validate the updated allocation rules in Phase 3 of the European Union Emissions Trading Scheme.

Keywords: EU ETS, emission trading, air pollution, cost pass-through, electricity, climate change

JEL Classification: H230, H320, Q480, Q520, Q530, Q540