Analyzing the Relationships Between Carbon, Electricity, and Natural Gas Markets

Understanding the Interconnectedness of European Energy Markets

The European energy landscape is currently undergoing a significant transformation, driven by the urgent need to address climate change and enhance energy security. In this context, the interconnections between carbon, electricity, and natural gas markets have emerged as critical factors influencing policy decisions and market stability. However, existing research often overlooks the dynamic nature of these interactions, particularly how major global events, such as the Russia–Ukraine conflict, reshape these market relationships.

The Importance of Dynamic Analysis

Current studies in European energy markets tend to provide static analyses, focusing on long-term trends without adequately addressing short- and medium-term fluctuations. This is crucial as markets tend to react differently based on time horizons. For instance, a sudden spike in natural gas prices can have immediate—but also delayed—effects on electricity costs and carbon allowances under the European Union Emissions Trading System (EU ETS). Such complex interactions necessitate a systematic approach for accurate analysis and targeted policy formulation.

Research Initiative at China University of Petroleum

To address these gaps, a research team from the School of Economics and Management and the Institute for Energy Economics and Policy at China University of Petroleum embarked on an ambitious study titled “Examining the Interactions of Carbon, Electricity, and Natural Gas Markets.” Their focus was specifically on European markets, utilizing key data sources such as EU ETS carbon prices, Dutch TTF natural gas prices, and Phelix electricity futures. The timeframe considered spanned from June 2012 to June 2022, enabling insights into significant events and their impact on market dynamics.

Methodological Framework

The research employs two sophisticated methodologies to explore price dynamics. The Diebold-Yilmaz spillover approach helps identify the origins and paths of price transmission among the three markets. This is complemented by the Time-Varying Parameter Stochastic Volatility Vector Autoregression (TVP-VAR) system, which analyzes multi-scale responses to price signals over different time horizons. By adjusting forecasting horizons—specifically to 30-day and 50-day intervals—the researchers can comprehensively assess how various market periods respond to specific shocks.

Key Findings on Market Interactions

The results of the study present a nuanced picture of market interactions. Initially, the natural gas market dominated price transmission, displaying short-term negative effects and medium-term positive impacts on the carbon market. However, the onset of the Russia–Ukraine conflict marked a significant shift: the electricity market became the primary price transmitter. In this new context, short-term effects turned positive, while medium-term impacts on the carbon market became negative. Surprisingly, the natural gas market no longer exerted substantial shocks on electricity prices.

Understanding the Total Spillover Index

The total spillover index (TCI) emerged as a critical metric in the study, averaging at 29.8%. Notably, this index experienced sharp increases during crises, peaking at 50% during the 2022 conflict. These fluctuations indicate that periods of instability can exacerbate inter-market dependencies, highlighting the importance of robust policy frameworks to mitigate adverse impacts. Additionally, the study found that the carbon market demonstrated positive effects on electricity in the short and medium terms but negative impacts in the long term, and that natural gas’s influence on carbon shifted considerably over time.

Dynamic Relationships Post-Conflict

Using an ALE-like analysis, the research further confirms that the influence of the electricity market on carbon prices has surpassed that of the natural gas market in the aftermath of the conflict. This finding reinforces the need for policymakers to consider the evolving relationships between these markets, especially as they work toward achieving carbon neutrality and a stable energy supply.