The marginal impacts of energy prices on carbon price variations: Evidence from a quantile-on-quantile approach

We uncover the marginal impacts of energy prices on carbon price variations across carbon-energy price distributions in Phase III of the European Union Emission Trading Scheme (EU ETS). Applying a novel Quantile-onQuantile (QQ) regression and the causality-in-quantiles approach, our empirical results demonstrate asymmetric and negative impacts of energy prices on carbon prices. The impacts are stronger at lower carbon quantiles and relatively smaller at higher quantiles (in absolute terms). Concerning different energy sources, the impacts of both oil and coal prices show a quasi-monotonic increase along with a rise in carbon quantiles; the absolute values of their impacts are much greater than that of the gas price impacts, depicting a relatively flat pattern. The results are consistent with our theoretical explanations which identify the two effect-transmission channels from energy to carbon prices, viz. the aggregated carbon demand effect and the fuel-switching effect. Thanks to the differences in energy sources and variability over their price distributions, the observed differential in carbon price-response is an indication of non-unique carbon market dynamics, the efficient management of which would require differentiated policy interventions. Robustness checks further confirm the accuracy of our conclusions. (c) 2021 Elsevier B.V. All rights reserved.

Automated summary

In Phase III of the European Union Emission Trading Scheme (EU ETS), energy prices have asymmetric and negative impacts on carbon prices, with stronger effects at lower carbon quantiles. The impacts of different energy sources vary, with oil and coal prices showing increasing effects with rising carbon quantiles, while gas prices have a relatively flat pattern. This differential carbon price-response indicates non-unique carbon market dynamics that require differentiated policy interventions.