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Integration and convergence in European electricity markets

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Abstract

This paper investigates the degree of integration among markets using wholesale electricity prices, which arises from the link between the long-run dynamics of fuel prices and electricity prices. We address the question of whether European electricity markets have experienced convergence patterns in recent years, using the stochastic definitions of convergence and common trend based on cointegration analysis. We apply a vector error correction model to a representative sample of electricity spot prices of European markets, including those of Italy, France, the Netherlands, Poland, and the integrated market of Germany and Austria. We analyze both the long- and the short-run system properties, studying their persistence profiles. The short-run analysis reveals the non-significance of adjustment coefficients of the market prices in the Netherlands and Poland. Moreover, the Netherlands Granger causes Poland and the integrated market of German and Austria, but the reverse is not true. A unidirectional Granger causality is also found for France and Germany and Austria toward Italy. Given the cointegrating equilibrium, all country-specific price dynamics converge toward the steady state, but most of the exogenous shocks have permanent effects. Forecast error variance decomposition analysis clearly highlights that orthogonalized shocks largely affect the variance of neighboring markets.

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Notes

  1. The milestones of the European Union electricity market deregulation process are the following (EC 2007). In 1996, a Parliamentary agreement was reached on a market liberalization directive; in 1997, the Directive 96/92EC was enacted concerning common rules for the internal market in electricity; in 1999, the transposition period ended; in 2001, a directive was adopted on the promotion of electricity from renewable energy sources in internal electricity markets; in 2003, directive 2003/54 was adopted; 2007 saw the publication of the results of an investigation criticizing the state of competition in the electricity sector; and in April 2009, the third package of directives concerning electricity markets was enacted (2009/28).

  2. Electricity market integration has been a crucial issue in several countries. Apergis et al. (2017) and de Menezes and Houllier (2016) have investigated the Australian case. Huisman and Kilic (2013), among others, have analyzed the European case.

  3. In October 2018, there was a split between the German and Austrian market zones. Further details are provided in Sect. 4.1.

  4. Data source is Data Stream for DEAU, FR, NET, and PL, and the IT data are freely available online on (http://www.mercatoelettrico.org/En/Tools/Accessodati.aspx?ReturnUrl=%2fEn%2fStatistiche%2fME%2fDatiSintesi.aspx). For DEAU, the distinction between the Austrian and German day-ahead electricity prices is quite difficult. The EXAA day-ahead electricity market enables electricity to be physically delivered not only in the Austrian control area, but also in the four German control areas. Similarly, the German segment at the EPEX SPOT day-ahead electricity market allows electricity to be physically delivered both in the four German transmission system operator (TSO) control areas and in the Austrian TSO control area. Using the data provided by these two markets, the DEAU data have been obtained computing the weighted average of the countries' series; authors have used daily exchanged quantities as weights. Finally, for oil, we use the London Brent Crude Oil Index.

  5. We would like to thank the Editor for this helpful comment.

  6. “Integration of renewable generation represents a key pillar of the European Commission's broader energy and climate objectives in reducing greenhouse gas emissions, improving the security of energy supply, diversifying energy supplies and improving Europe's industrial competitiveness.” (EC 2014, p. i)

  7. Since October 2018, the German and Austrian market zone has been split due to regional congestion problems. Germany's RES growth resulted in a massive increase in cheap wind power in the north of the country, but the lack of a connecting network in the industrialized south of the Germany pushed green electricity surplus toward (and through) the grids of Poland and Czech Republic compromising their stability. Furthermore, the absence of any trading limitations on that border has also reduced energy exchange capacities available on other regional borders. Finally, this market separation is determining opposite price dynamics in German and Austrian markets with a second market that is characterized by an appreciable electricity price increase.

  8. Spillover effects have been deeply investigated in financial markets using GARCH models (see, among others, Beirne et al. 2013; Sola et al. 2002).

  9. The size of all the shocks analyzed in this section is set equal to one standard deviation.

  10. Half-life is defined as the number of months after which the deviation from the steady state falls to half the size of the initial shock.

  11. We recall that Germany's green energy transformation resulted in severe congestion problems in the region, undermining the stability of Polish and Czech grids, and reducing their borders' electricity exchange capacities.

  12. Between these two countries, several interactions occurred. Among others, the average wind speed in Germany negatively affects Dutch electricity prices. This effect is fairly constant despite the significant increase in German wind energy capacity (Mulder and Scholtens 2013). Further, the Netherlands is currently the biggest importer of Germany’s extra power, with a net 12.7 TWh flowing across the border into its power grid already since 2016.

  13. This result is consistent with the evidence provided by Bosco et al. (2010), where a long-run relation between electricity and oil price is detected.

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Acknowledgements

This research was supported by the Italian Ministry of Education, University and Research: project PRIN 2007, “Real structure and empirical models of the Italian electricity market: an analysis for the design market transfer to the South Eastern European countries”. A preliminary version of this paper was presented at the: XIX International “Tor Vergata” Conference on Money, Banking and Finance “New Frontiers of Banking and Finance after the Global Crisis”, Rome, December 13–17, 2010; 30th USAEE/IAEE North American Conferences: “Redefining the Energy Economy: Changing Roles of Industry, Government and Research”; October 9–12, 2011; WASHINGTON, DC; 34th IAEE International Conference—Institutions, Efficiency and Evolving Energy Technologies—Stockholm, June 19–23, 2011; 53rd Annual Conference of the Italian Economic Association, October 18–20, 2012, Matera (Italy); we are indebted to all participants. The authors are also thankful to Simona Bigerna, Carlo Andrea Bollino, Paolo Bruno Bosco, Paolo Falbo, Lucia Parisio, Matteo Pelagatti, Silvana Stefani, an anonymous referee, and the Editor for their helpful suggestions and remarks. The usual disclaimer applies. Finally, we would like to thank Associate Editor and reviewers for careful reading, and constructive suggestions for our manuscript.

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  1. Cassa Depositi e Prestiti, Via Goito 4, 00185, Rome, Italy

    Davide Ciferri

  2. Department of Economics, University of Perugia, via A. Pascoli 20, 06123, Perugia, Italy

    Maria Chiara D’Errico & Paolo Polinori

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Ciferri, D., D’Errico, M.C. & Polinori, P. Integration and convergence in European electricity markets. Econ Polit 37, 463–492 (2020). https://doi.org/10.1007/s40888-019-00163-7

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