Does California's CO₂ price affect wholesale electricity prices in the Western U.S.A.?

Using a sample of daily market data, we quantify the effect of California's CO₂ cap-and-trade program on the wholesale electricity prices of four interconnected market hubs in the Western U.S.A.: North of Path 15 (NP15) and South of Path 15 (SP15) in California, Mid-Columbia (Mid-C) in the Pacific Northwest, and Palo Verde (PV) in the Desert Southwest. A $1/metric ton increase in California's CO₂ price is estimated to have increased the electricity prices by $0.41/MWh (p-value < 0.0001) for NP15, $0.59/MWh (p-value < 0.0001) for SP15, $0.41/MWh (p-value = 0.0056) for Mid-C, and $0.15/MWh (p-value = 0.0925) for PV. These estimates reflect: (a) the NP15 and SP15 sellers’ pricing behavior of fully including the CO₂ price in their intra-state transactions; (b) the Mid-C price's 100% pass-through of the CO₂ price in the Pacific Northwest's hydro export to California; and (c) the statutory obligation of paying the CO₂ emissions cost by California's buyers of the electricity imported from the Desert Southwest. The policy implication is that internalization of CO₂'s externality in the Western U.S.A. requires a cap-and-trade program with a regional scope that encompasses all four hubs, thereby remedying the California program's limited geographic coverage which introduces distortions in neighboring markets. Copyright © 2017 Elsevier Ltd.