CO 2 cost pass-through and windfall profits in the power sector

“Similarly, because of startup costs, power stations may prefer to operate during off-peak periods (Sijm et al., 2006).”

“Formally, the pass-on rate can be measured as the change in a good's unit sales price in response to energy price changes (Sijm et al., 2006).”

“Furthermore, Sijm et al. 2006 shows that Europe’s power companies have made well over €1 billion profits from the EU ETS to date, and suggests that the sector will make net profits of tens of billions of euros during the second phase.”

“Numerous studies have demonstrated that electricity companies have reaped windfall profits by passing through the allowance price to their consumers while they had received the allowances for free (Sijm et al., 2006).”

“A third strand of research has concentrated on the linkages between European carbon prices and electricity prices (Sijm et al., 2006; Lu et al., 2012; Aatola et al., 2013; de Menezes et al., 2016) based on the rationale that the electricity sector is affected by carbon prices because of its large…”

“This assumption has been adopted in similar analyses (Sijm et al., 2006; Hepburn et al., 2007; Wirl, 2007) as well as for describing demand in the energy market and in the tradable white certificates market (Sorrell et al., 2009).”

“Reduction in windfall profits From January 2005 to mid-2006, when the price of CO2 allowances was high, 8 electricity suppliers passed the greatest part of the cost of allowances onto their sale price (Sijm et al., 2006; Fell, 2008).”

“Empirical studies on cost pass-through and windfall profits in the Dutch and German power sectors estimate that pass-through rates range from 60-100% for wholesale power markets (Sijm et al. 2006).”

“Energy suppliers thus benefit from a windfall profit under this policy instrument, as they do under the EU ETS (Sijm et al., 2006).”

“The price parameters are estimated following standard steps using the maximum likelihood method given in the appendix of Tseng and Barz (2002).”

“The extra costs of fossil-fuel-based power generation thus impact on wholesale electricity prices, in line with the carbon intensity of the marginal production unit (Sijm et al., 2006).”

“phase, these allowances, which are priced daily by the market, reflect new liquid assets which can be regarded as the opportunity cost of carbon at the market price (Sijm et al. 2006).”

“Auction arguably performs better than free allocation because the former allocates allowances to enterprises with the strongest demands, avoids unfairness related to “windfall profit” [23], and reduces rent-seeking and investment distortion [24–26].”

“The theoretical foundation of the CO 2 cost pass-through to electricity prices is well established in the scienti fi c literature, as presented by Sijm et al. (2006) in the context of perfect competition, and by Bonacina and Gulli (2007) for markets under imperfect competition.”

“In Phase I of the EU emissions trading scheme, electricity generators were able to pass on to consumers the price of carbon permits, even though these had been allocated to them for free by the government (Sijm et al. 2006).”

“In fact, according to Sijm et al. (2006), the carbon cost pass-through rate in Europe varies between 60% and 100%.”

“The ‘add-on’ pass-through rates are the carbon intensity rates of generators (Sijm et al. 2006).”

“Sijm et al. (2006) found that the passthrough rate was dependent on the carbon intensity of the marginal production unit, market structure, and other technology factors.”

“At average current market prices for 2005, this represented a social value of approximately EUR 40 billion p.a., ca. 60% of which was allocated to the power sector (Sijm et al., 2006).”

“This could lead to windfall profits to the extent that airlines pass forward emissions prices into higher ticket prices, just as power companies received large windfall profits from free allowance allocations in the initial stages of the EU-ETS (Sijm et al., 2006).”

“Since Bovenberg and Goulder (2002), Sijm, Neuhoff, and Chen (2006), and Smale, Hartley, Hepburn, Ward, and Grubb (2006) have shown that, where companies pass on the opportunity costs of pollution licences into consumer prices, 100% free allocation leads to windfall profits for polluting industry.”

“However, if a company can pass the cost through to consumers, then the financial cost borne by the company is neutral (Sijm et al., 2006).”

“In particular, large electricity consumers claim that utilities benefit from windfall profits, passing the value of CO2 emissions on to prices although they receive allowances for free (Sijm et al., 2006).”

“Empirical studies on cost pass-through and windfall profits in the Dutch and German power sectors estimate that pass-through rates range from 60 to 100 % for wholesale power markets (Sijm et al. 2006).”

“Several researchers (e.g. Fezzi and Bunn, 2010; Sjim et al., 2006; Pinho and Madaleno, 2011) analyzed how carbon costs are linked to electricity prices.”

“Thus, to calculate the amount of pass-through requires information about what technology is on the margin at any given point in time ( Sijm et al. 2006 ).”

“According to Sijm et al. (2006) for example, the carbon cost pass-through rate in Europe varies between 60% and 100%.”

“10 Thus rates found are here are somewhere between the findings of Sijm et al. (2006) and full pass through.”

“5 For instance, Sijm et al. (2006) for Germany and the Netherlands, Simshauser and Doan (2009) for Australia, and Fell (2010) for the Nordic market.”

“In a sophisticated boot-strapping econometric exercise, Sijm, Neuhoff, and Chen (2006) examined the impact of EUA price changes on the cost of generating from coal in Germany, finding complete pass-through for peak prices and 60–70% for off-peak prices (when interconnectors are less constrained and…”

“By contrast, the differentiation instituted between power consuming and power producing sectors implies that electricity suppliers will need to buy all allowances, otherwise they could easily pass the costs to end-producers, leading to ‘windfall profits’ (Sijm et al., 2006).”

“Sijm et al (2006) found that in Germany and the Netherlands – two significant primary aluminium producing countries – average CO 2 cost pass-through rates of roughly 90% and 70% (respectively) could be observed in Phase I.”

“A number of studies examine pass-through in a reduced-form setting and find rates ranging from well below unity to 20% above full pass-through (e.g., see Sijm et al. (2006a)).”

“See Sijm et al. (2006) for estimates of the CO2 cost pass-through in Germany and the Netherlands; empirical and model data are presented that indicate that pass-through rates vary between 40 and 60%.”

“Furthermore, we assume vi1a v i2 b ; 8i1; i2 and ei1 ei2 ;8vi2 vi2 , that is, the cleaner technology is also the higher variable cost technology (Sijm et al. 2006).”

“The results could be explained by a combination of cost pass-through to consumers and a very generous free allocation policy (Hintermann 2011; Sijm et al. 2006).”

“7 Sijm, Neuhoff, and Chen (2006) provide empirical evidence for this phenomenon based on lump sum allocations to electricity generators in the first phase of the European Union Emission Trading Scheme.”

“Therefore, the auctioning of some fraction of allowances under a SB scheme is likely to be necessary to avoid windfall profits being captured by generators 8 (Palmer et al., 2006; Sijm et al., 2006).”

“2 Sijm et al. (2008) extend the analysis to seven other EU ETS countries and a longer period.”

“Specifically, various researchers identified an increase in electricity prices under the pretence of the substantial carbon costs (e.g., Keats and Neuhoff 2005; Sijm et al. 2006).”

“Sijm et al. (2006) estimate pass-through rates between 60% and 100% of CO 2 cost for this sector in Germany and the Netherlands.”

“In Phase I of the EU ETS, such profits were observed in the power sector (Betz and Sato, 2006; Sijm et al., 2006).”

“The quite exceptional position of Aluminium, as noted in Smale (2006), is readily apparent – its trade intensity is almost twice that of any other sector.”