California´s carbon market and energy prices: a wavelet analysis

Abstract

Carbon price is a key variable in management and risk decisions in activities related to the burning of fossil fuels. Different major players in this market, such as polluters, regulators, and fi nancial actors have different time horizons. Using innovative multi-variate wavelet analysis tools, including partial wavelet coherency and partial wavelet gain, we study the link between carbon prices and final energy prices in the time and frequency dimensions in California´ s carbon market, officially known as the California cap-and-trade program. We find that gasoline prices lead an anti-phase relation with carbon prices. This result is very stable at lower frequencies (close to one-year period cycles), and it is also present before mid-2015 in the 20 ~ 34 weeks frequency-band. Regarding electricity, we find that at about 1 year frequencies, a rise in carbon prices is refl ected in higher electricity prices. We conclude that the fi rst five years of compliance of the California cap-and-trade program supports the idea that emissions´ trading is a signi cant measure for climate change mitigation, with visible rising carbon prices. The quantitative financial analytics we present here supports the continuation of the program after 2020.