CO₂cost pass-through and windfall profits in the power sector

TLDR

Power companies receive most EU ETS allowances for free and, in line with economic theory, pass those costs onto electricity prices. The article examines how free CO₂ allowance allocation affects electricity prices and power plant profitability under the EU ETS. The study combines theoretical discussion with empirical and model estimates of CO₂ cost pass‑through in Germany and the Netherlands, showing rates between 60–100 % depending on marginal unit intensity and market or technology factors. The analysis finds that power firms earn significant windfall profits from CO₂ allowance costs.

Abstract

Abstract In order to cover their CO2 emissions, power companies receive most of the required EU ETS allowances for free. In line with economic theory, these companies pass on the costs of these allowances in the price of electricity. This article 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. As well as some theoretical reflections, the article presents empirical and model estimates of CO2 cost pass-through for Germany and The Netherlands, indicating that pass-through rates vary between 60 and 100% of CO2 costs, depending on the carbon intensity of the marginal production unit and various other market- or technology-specific factors. As a result, power companies realize substantial windfall profits, as indicated by the empirical and model estimates presented in the article.