TIME VARYING LONG RUN DYNAMICS AND CONVERGENCE IN THE UK ENERGY MARKET

Melanie Houllier, Lilian M. De Menezes and Michael Tamvakis

No 6970, EcoMod2014 from EcoMod

Abstract: For a long time fuels such as gas, coal or oil have been the most important cost items for power generation accounting for 70% of the variable costs (Crampes and Fabra, 2005), since they were usually marginal generation technologies that set wholesale prices (Bosco et al., 2010). Intuitively, long run dynamics of electricity prices should therefore reflect fuel price developments, at least in markets with a significant share in their energy mix. However, with the EU Directive 2009/28/EC, EU Member States have established national action plans, which set the share of energy from renewable sources for 2020 (20-20-20 targets) (EC, 2009). The EU Renewable Energy Target decreed that 15% of all energy (or 30-35% of electricity) is to be generated by RES-E by 2020 in the UK. This change in energy mix may have altered traditional associations between fuel inputs and price behaviour, at least in the short run. We therefore identify changes in wholesale price dynamics, using weekdaily APX spot prices from February 2003 to October 2013, and investigate their association with gas and coal prices as well as wind penetration levels. Localized autocorrelation (Cardinali and Nason, 2013) are used to identify changes of long run dynamics in the time series. Cointegration analysis (Engle and Granger 1987) and fractional co-integration analysis are then employed to investigare common long run dynamics in the UK energy sector for stationary and non-stationary periods respectively. UK electricity spot prices are found to be locally non-stationary processes (see Figure 1), which means that there are periods when prices are stable around a level and others when the time series describe a trend that is associated with the dominant fossil fuel being used. During these non-stationary periods, UK electricity spot prices are shown to have common long run dynamics with fossil fuels. During stationary periods, shocks can take a while to dilute, as it is observed that the price series shows long-memory behaviour. In such periods, wind penetration levels are significantly associated with spot price dynamics. In all, the results illustrate how different inputs influence wholesale prices and how a changing energy mix may affect the long run dynamics in the UK electricity market.

Keywords: UK; Macroeconometric modeling; Energy and environmental policy (search for similar items in EconPapers)
Date: 2014-07-03
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Persistent link: https://EconPapers.repec.org/RePEc:ekd:006356:6970

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