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Interaction of carbon and electricity prices under imperfect competition

  • Chernyavs’ka, Liliya
  • Gullì, Francesco
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    In line with economic theory, carbon ETS determines a rise in marginal cost equal to the carbon opportunity cost regardless of whether carbon allowances are allocated free of charge or not. Hence, common sense would suggest that .rms in imperfectly competitive markets will pass-through into electricity prices only a part of the increase in cost. Instead, by using the load duration curve approach and the dominant .rm with competitive fringe model, the analysis proposed in this paper shows that the result is ambiguous. The increase in price can be either lower or higher than the marginal CO2 cost depending on several structural factors: the degree of market concentration, the available capacity (whether there is excess capacity or not) and the power plant mix in the market; the allowance price and the power demand level (peak vs. off-peak hours). The empirical analysis of the Italian context (an emblematic case of imperfectly competitive market), which can be split in four sub-markets with different structural features, confirms the model predictions. Market power, therefore, can determine a significant deviation from the "full pass-through" rule but we can not know which is the sign of this deviation, a priori, i.e. without before carefully accounting for the structural features of the power market.

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    File URL: http://mpra.ub.uni-muenchen.de/5866/1/MPRA_paper_5866.pdf
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    Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 5866.

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    Date of creation: May 2007
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    Handle: RePEc:pra:mprapa:5866
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    1. 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.
    2. von der Fehr, Nils-Henrik Morch & Harbord, David, 1993. "Spot Market Competition in the UK Electricity Industry," Economic Journal, Royal Economic Society, vol. 103(418), pages 531-46, May.
    3. Burtraw, Dallas & Palmer, Karen & Bharvirkar, Ranjit & Paul, Anthony, 2001. "The Effect of Allowance Allocation on the Cost of Carbon Emission Trading," Discussion Papers dp-01-30-, Resources For the Future.
    4. Frank A. Wolak & Robert H. Patrick, 2001. "The Impact of Market Rules and Market Structure on the Price Determination Process in the England and Wales Electricity Market," NBER Working Papers 8248, National Bureau of Economic Research, Inc.
    5. von der Fehr, N.-H. & Harbord,D., 1998. "Competition in Electricity Spot Markets. Economic Theory and International Experience," Memorandum 05/1998, Oslo University, Department of Economics.
    6. 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).
    7. Bolle, Friedel, 1992. "Supply function equilibria and the danger of tacit collusion : The case of spot markets for electricity," Energy Economics, Elsevier, vol. 14(2), pages 94-102, April.
    8. Requate, Till, 2005. "Environmental Policy under Imperfect Competition : A Survey," Economics Working Papers 2005,12, Christian-Albrechts-University of Kiel, Department of Economics.
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