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CO2 cost pass through and windfall profits in the power sector

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Author Info
Sijm, J.
Neuhoff, K.
Chen, Y.

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Abstract

This paper analyses the implications of the EU ETS for the power sector, notably the impact of free allocation of CO2 emission allowances on the price of electricity and the profitability of power generation. Besides some theoretical reflections, the paper presents empirical and model estimates of CO2 cost pass through, indicating that pass through rates vary between 40 and 100 percent of CO2 costs, or - in absolute terms - between 3 and 18 €/MWh, depending on the carbon intensity of the marginal production unit and other, market or technology specific factors concerned. As a result, power companies realise substantial windfall profits, indicated by empirical and model estimates presented in the paper. In order to avoid these windfall profits, the paper concludes that free allocation to power companies should be phased out in favour of auctioning.

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Publisher Info
Paper provided by Faculty of Economics, University of Cambridge in its series Cambridge Working Papers in Economics with number 0639.

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Length: 30
Date of creation: May 2006
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Handle: RePEc:cam:camdae:0639

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Related research
Keywords: Emissions trading; allocation; CO2 cost pass through; windfall profits; power sector;

Find related papers by JEL classification:
C81 - Mathematical and Quantitative Methods - - Data Collection and Data Estimation Methodology; Computer Programs - - - Microeconomic Data
L11 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Production, Pricing, and Market Structure; Size Distribution of Firms
L94 - Industrial Organization - - Industry Studies: Transportation and Utilities - - - Electric Utilities

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References listed on IDEAS
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  1. Burtraw, Dallas & Palmer, Karen & Bharvirkar, Ranjit & Paul, Anthony, 2002. "The Effect on Asset Values of the Allocation of Carbon Dioxide Emission Allowances," Discussion Papers dp-02-15-, Resources For the Future. [Downloadable!]
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  2. Burtraw, Dallas & Palmer, Karen & Kahn, Daniel, 2005. "Allocation of CO2 Emissions Allowances in the Regional Greenhouse Gas Cap-and-Trade Program," Discussion Papers dp-05-25, Resources For the Future. [Downloadable!]
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Oberndorfer, Ulrich, 2008. "EU Emission Allowances and the Stock Market: Evidence from the Electricity Industry," ZEW Discussion Papers 08-059, ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research. [Downloadable!]
  2. Pablo del Río & Javier Carrillo-Hermosilla & Totti Könnölä & Carlos Suárez, 2008. "Challenges and opportunities of a post-Kyoto mitigation regime: a survey of the European electricity sector," Mitigation and Adaptation Strategies for Global Change, Springer, vol. 13(8), pages 863-885, October. [Downloadable!] (restricted)
  3. E. Woerdman & O. Couwenberg & A. Nentjes, 2009. "Energy prices and emissions trading: windfall profits from grandfathering?," European Journal of Law and Economics, Springer, vol. 28(2), pages 185-202, October. [Downloadable!] (restricted)
  4. Juha Honkatukia & Ville Mälkönen & Adriaan Perrels, 2006. "Impacts of the European Emission Trade System on Finnish Wholesale Electricity Prices," Discussion Papers 405, Government Institute for Economic Research Finland (VATT). [Downloadable!]
  5. Chernyavs’ka, Liliya & Gullì, Francesco, 2007. "Interaction of carbon and electricity prices under imperfect competition," MPRA Paper 5866, University Library of Munich, Germany. [Downloadable!]
  6. Derek W. Bunn & Carlo Fezzi, 2007. "Interaction of European Carbon Trading and Energy Prices," Working Papers 2007.63, Fondazione Eni Enrico Mattei. [Downloadable!]
  7. Lambie, N. Ross, 2009. "The role of real options analysis in the design of a greenhouse gas emissions trading scheme," 2009 Conference (53rd), February 11-13, 2009, Cairns, Australia 47626, Australian Agricultural and Resource Economics Society. [Downloadable!]
  8. Parry, Ian W.H. & Goulder, Lawrence H., 2008. "Instrument Choice in Environmental Policy," Discussion Papers dp-08-07, Resources For the Future. [Downloadable!]
    Other versions:
  9. Sophie Chemarin & Andreas Heinen & Eric Strobl, 2008. "Electricity, carbon and weather in France: where do we stand ?," Working Papers hal-00340171_v1, HAL. [Downloadable!]
  10. Yihsu Chen & Jos Sijm & Benjamin Hobbs & Wietze Lise, 2008. "Implications of CO2 emissions trading for short-run electricity market outcomes in northwest Europe," Journal of Regulatory Economics, Springer, vol. 34(3), pages 251-281, December. [Downloadable!] (restricted)
  11. Janssen, Matthias & Wobben, Magnus, 2008. "Electricity Pricing and Market Power - Evidence from Germany," MPRA Paper 11400, University Library of Munich, Germany. [Downloadable!]
  12. Sato, S. & Grubb, M. & Cust, J. & Chan, K. & Korppoo, A. & Ceppi, P., 2007. "Differentiation and dynamics of competitiveness impacts from the EU ETS," Cambridge Working Papers in Economics 0712, Faculty of Economics, University of Cambridge. [Downloadable!]
  13. Burtraw, Dallas & Evans, David A., 2008. "Tradable Rights to Emit Air Pollution," Discussion Papers dp-08-08, Resources For the Future. [Downloadable!]
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