Pass-Through of Emissions Costs in Electricity Markets

TLDR

We measure the pass‑through of emissions costs to electricity prices. We use both reduced‑form and structural estimations based on optimal bidding, leveraging rich micro‑level data to flexibly estimate the channels affecting pass‑through with minimal functional‑form assumptions. Contrary to many studies in the general pass‑through literature, we find that emissions costs are almost fully passed through to electricity prices because electricity is traded through high‑frequency auctions for highly inelastic demand, firms have weak incentives to adjust markups after the cost shock, and the costs of price adjustment are small. JEL codes: D44, L11, L94, L98, Q52, Q54.

Abstract

We measure the pass-through of emissions costs to electricity prices. We perform both reduced-form and structural estimations based on optimal bidding in this market. Using rich micro-level data, we estimate the channels affecting pass-through in a flexible manner, with minimal functional form assumptions. Contrary to many studies in the general pass-through literature, we find that emissions costs are almost fully passed through to electricity prices. Since electricity is traded through high-frequency auctions for highly inelastic demand, firms have weak incentives to adjust markups after the cost shock. Furthermore, the costs of price adjustment are small. (JEL D44, L11, L94, L98, Q52, Q54)