The impact of phase II of the EU ETS on wholesale electricity prices

This paper addresses the economic impact of the European Union Emission Trading Scheme (EU ETS) for carbon on wholesale electricity prices in France and Germany during the Kyoto commitment period (2008-2012). We identify a structural break occurred on the carbon spot price series in October 2008, which is mainly resulting from the financial and economic crisis. We find that the price of carbon does not matter for electricity prices in either countries before October 2008. Electricity producers in both countries were facing uncertainties regarding the future of the EU ETS and thus adopted a wait and see attitude until the end of 2008. The communication of national allocation plans (NAPs) in late October 2008, and the definitive adoption of the European Union climate and energy package by the European Parliament in December 2008 puts an end to these uncertainties. We find also that after October 2008, electricity producers in both countries were constrained to include the carbon price in their cost functions. During that period, French electricity producers were more constrained than their German counterparts, the elasticity of the electricity price relative to the price of carbon being higher in France than in Germany. By comparing the results with those in Kirat and Ahamada [2011] concerning the first phase of the EU ETS we conclude that the changes in the EU ETS introduced in phase II (banking and lower allowances in NAPs) have rendered the carbon market more efficient. Finally, we find a higher conditional correlation between wholesale electricity prices in France and Germany during the second phase of the EU ETS reflecting more integrated French and German electricity markets.