ELECTRICITY MARKETS AND ENVIRONMENTAL POLICIES: EVIDENCE ON THE ELECTRICITY PRICE PASS-TROUGH IN ITALY

Abstract

This thesis empirically studies the complex interactions between environmental policies and the electricity price by analyzing the evolution of the electricity price pass-through of the European carbon emissions allowances (EU ETS). By exploiting plant level bid data for the Italian day-ahead electricity market for the years between 2005 and 2015 together with data on plant level emissions’ intensity, the pass-through rate is estimated, using an instrumental variable strategy, separately for each one of the three phases of the ETS: between 2005 and 2007 (phase I), between 2008 and 2012 (phase II) and between 2013 and 2015 (phase III). The main result that this thesis uncovers a substantial decrease across the three phases of estimated pass-through that passes from being 70 percent in phase I to 30 percent in phase II and, finally, essentially zero in phase III. This finding is confirmed by the outcomes of an extensive set of robustness checks involving the performance of the instrument, the model specification and the analysis sample. The second main results concerns an assessment of the potential drivers of the pass-through decline. By exploring both supply and demand factors, the study reveals that demand factors can contribute to the observed reduction between phase I and phase II, but that the decline in phase III is best accounted for by changes in the supply side. In particular, the composition of the sellers in terms of a shift from traditional electricity generators towards financial operators triggered by regulatory reforms occurred in 2012 turns out to be a critical driver of the decreased pass-through. This results underscores the importance of accounting for the sophisticated trading strategies of financial traders in the design of policies affecting markets like the electricity and ETS markets where both these players and the traditional electricity suppliers are simultaneously present.