Journal of Energy Markets

Risk.net

Evaluating the effects of changing market parameters and policy implications in the German electricity market

Christian Hendricks and Matthias Ehrhardt

ABSTRACT

In this paper the authors introduce a joint model for the electricity spot and the emission market in Germany. The model is used to simulate the effects of changing market parameters and policy implications. They propose a structural approach to connect fundamental factors, such as demand, capacity, fuel prices and emission allowances, to the price of electricity. Based on empirical bid behavior of electricity producers in day-ahead auctions they develop a novel CO2 emission rate model. In order to introduce a feedback of CO2 allowances to the actual emission of greenhouse gases, a forward-backward stochastic differential equation is used to deduce a partial differential equation to price emission allowances. The resulting equation will be solved by an alternating direction implicit finite difference scheme.