Evidence for threshold effects in the pass-through of carbon prices to wholesale electricity prices

This article considers the evidence for threshold effects in the relationship between electricity and emission permit prices in France and Germany during the second phase of the EU ETS. Specifically, we compare linear and nonlinear threshold models of electricity prices using Hansen's (2000) approach of sample splitting and threshold estimation. We find evidence of nonlinear threshold effects in both countries. The estimated carbon price thresholds are 14.94 and 12.57 euros in France and Germany, respectively. The carbon price threshold in France perfectly coincides with the well-known carbon spot price structural break occurred on October 2008. This is not the case for the carbon price threshold in Germany. An in-depth analysis reveals that during the period before October 2008, carbon prices were not reflected in electricity prices in either countries. This is mainly due to uncertainties about the future of the EU ETS that have led electricity producers to adopt a wait and see behavior. After October 2008, French electricity producers passthrough the price of emission permits into electricity prices in a linear way, while their German counterparts do so nonlinearly.