Are electricity risk premia affected by emission allowance prices? Evidence from the EEX, Nord Pool and Powernext
The links between emission and energy markets are of great interest to practitioners, academics and policy makers. In this paper, it is conjectured that a positive relationship exists between emission allowance spot returns and electricity risk premia within the European Union Emissions Trading Scheme (EU ETS). We discuss how this can be justified on the basis of the substantial uncertainties in the carbon markets. We also argue that this link could be due to trading strategies followed by electricity producers who attempt to exploit their initial allocation of free allowances. Analysis of data from three major markets, the EEX, Nord Pool and Powernext, offers empirical support to our conjecture. These findings have significant policy implications since they imply that efforts should be made in order to reduce the uncertainty in the carbon markets by clearly defining the EU ETS regulative framework and design over the next years. Moreover, our results suggest that the allocation of free allowances and their unrestricted trading enable electricity producers to accomplish windfall profits in the derivatives market at the expense of other market participants.
References listed on IDEAS
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.:
- Seifert, Jan & Uhrig-Homburg, Marliese & Wagner, Michael, 2008. "Dynamic behavior of CO2 spot prices," Journal of Environmental Economics and Management, Elsevier, vol. 56(2), pages 180-194, September.
- Sijm, J. & Neuhoff, K. & Chen, Y., 2006.
"CO2 cost pass through and windfall profits in the power sector,"
Cambridge Working Papers in Economics
0639, Faculty of Economics, University of Cambridge.
- Jos Sijm & Karsten Neuhoff & Yihsu Chen, 2006. "CO 2 cost pass-through and windfall profits in the power sector," Climate Policy, Taylor & Francis Journals, vol. 6(1), pages 49-72, January.
- Breeden, Douglas T, 1980. " Consumption Risk in Futures Markets," Journal of Finance, American Finance Association, vol. 35(2), pages 503-20, May.
- Domanico, Fabio, 2007. "Concentration in the European electricity industry: The internal market as solution?," Energy Policy, Elsevier, vol. 35(10), pages 5064-5076, October.
- Montgomery, W. David, 1972. "Markets in licenses and efficient pollution control programs," Journal of Economic Theory, Elsevier, vol. 5(3), pages 395-418, December.
- Iivo Vehvilainen, 2002. "Basics of electricity derivative pricing in competitive markets," Applied Mathematical Finance, Taylor & Francis Journals, vol. 9(1), pages 45-60.
- Kara, M. & Syri, S. & Lehtila, A. & Helynen, S. & Kekkonen, V. & Ruska, M. & Forsstrom, J., 2008. "The impacts of EU CO2 emissions trading on electricity markets and electricity consumers in Finland," Energy Economics, Elsevier, vol. 30(2), pages 193-211, March.
- Kolos, Sergey P. & Ronn, Ehud I., 2008. "Estimating the commodity market price of risk for energy prices," Energy Economics, Elsevier, vol. 30(2), pages 621-641, March.
- Daskalakis, George & Psychoyios, Dimitris & Markellos, Raphael N., 2009. "Modeling CO2 emission allowance prices and derivatives: Evidence from the European trading scheme," Journal of Banking & Finance, Elsevier, vol. 33(7), pages 1230-1241, July.
- H�lyette Geman & Andrea Roncoroni, 2006. "Understanding the Fine Structure of Electricity Prices," The Journal of Business, University of Chicago Press, vol. 79(3), pages 1225-1262, May.
- Francis A. Longstaff & Ashley W. Wang, 2004. "Electricity Forward Prices: A High-Frequency Empirical Analysis," Journal of Finance, American Finance Association, vol. 59(4), pages 1877-1900, 08.
- Deng, S.J. & Oren, S.S., 2006. "Electricity derivatives and risk management," Energy, Elsevier, vol. 31(6), pages 940-953.
- Fred Espen Benth & Alvaro Cartea & Ruediger Kiesel, 2006.
"Pricing Forward Contracts in Power Markets by the Certainty Equivalence Principle: Explaining the Sign of the Market Risk Premium,"
Birkbeck Working Papers in Economics and Finance
0611, Birkbeck, Department of Economics, Mathematics & Statistics.
- Benth, Fred Espen & Cartea, Álvaro & Kiesel, Rüdiger, 2008. "Pricing forward contracts in power markets by the certainty equivalence principle: Explaining the sign of the market risk premium," Journal of Banking & Finance, Elsevier, vol. 32(10), pages 2006-2021, October.
- Derek W. Bunn & Carlo Fezzi, 2007. "Interaction of European Carbon Trading and Energy Prices," Working Papers 2007.63, Fondazione Eni Enrico Mattei.
- Hazuka, Thomas B, 1984. " Consumption Betas and Backwardation in Commodity Markets," Journal of Finance, American Finance Association, vol. 39(3), pages 647-55, July.
- Fama, Eugene F & French, Kenneth R, 1987. "Commodity Futures Prices: Some Evidence on Forecast Power, Premiums,and the Theory of Storage," The Journal of Business, University of Chicago Press, vol. 60(1), pages 55-73, January.
- Mork, Erling, 2001. "Emergence of financial markets for electricity: a European perspective," Energy Policy, Elsevier, vol. 29(1), pages 7-15, January.
- Weron, Rafal, 2008. "Market price of risk implied by Asian-style electricity options and futures," Energy Economics, Elsevier, vol. 30(3), pages 1098-1115, May.
- Geman, Hélyette & Roncoroni, Andréa, 2006. "Understanding the Fine Structure of Electricity Prices," Economics Papers from University Paris Dauphine 123456789/1433, Paris Dauphine University.
- Nakamura, Masao & Nakashima, Tomoaki & Niimura, Takahide, 2006. "Electricity markets volatility: estimates, regularities and risk management applications," Energy Policy, Elsevier, vol. 34(14), pages 1736-1749, September.
- Diko Pavel & Lawford Steve & Limpens Valerie, 2006. "Risk Premia in Electricity Forward Prices," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, vol. 10(3), pages 1-24, September.
- Hendrik Bessembinder & Michael L. Lemmon, 2002. "Equilibrium Pricing and Optimal Hedging in Electricity Forward Markets," Journal of Finance, American Finance Association, vol. 57(3), pages 1347-1382, 06.
- Pedro Linares & Francisco Javier Santos & Mariano Ventosa & Luis Lapiedra, 2006. "Impacts of the European Emissions Trading Scheme Directive and Permit Assignment Methods on the Spanish Electricity Sector," The Energy Journal, International Association for Energy Economics, vol. 0(Number 1), pages 79-98.
- repec:cup:cbooks:9780521710091 is not listed on IDEAS
When requesting a correction, please mention this item's handle: RePEc:eee:enepol:v:37:y:2009:i:7:p:2594-2604. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Zhang, Lei)
If references are entirely missing, you can add them using this form.