Modeling European Electricity Market Integration during turbulent times

TL;DR

This paper presents a Bayesian mixed-frequency model to analyze European electricity market integration, revealing how renewable energy reduces prices and fossil fuels influence market disparities during turbulent times.

Contribution

Introduces a novel hierarchical Bayesian model capturing cross-country interdependencies and effects of renewable and fossil fuel prices on electricity prices.

Findings

Renewable energy consistently lowers electricity prices across countries.

Gas prices are the main factor driving price disparities and instability.

Market integration can both mitigate and amplify shocks.

Abstract

This paper introduces a novel Bayesian reverse unrestricted mixed-frequency model applied to a panel of nine European electricity markets. Our model analyzes the impact of daily fossil fuel prices and hourly renewable energy generation on hourly electricity prices, employing a hierarchical structure to capture cross-country interdependencies and idiosyncratic factors. The inclusion of random effects demonstrates that electricity market integration both mitigates and amplifies shocks. Our results highlight that while renewable energy sources consistently reduce electricity prices across all countries, gas prices remain a dominant driver of cross-country electricity price disparities and instability. This finding underscores the critical importance of energy diversification, above all on renewable energy sources, and coordinated fossil fuel supply strategies for bolstering European energy security.