1. Introduction
Since the Russia–Ukraine conflict, global energy prices have risen rapidly. In response to climate change, European countries have been increasing their share of renewable energy generation to have a clean energy transition, which can further support the aims announced in the Paris Agreement [
1]. Although the EU Green Deal calls for climate neutrality by 2050 and emission reductions of 50–55% in 2030 in comparison to 1990, and EU Member States’ Green Deal responses in their final NECPs addressed most of the critical components [
2], it will increase the cost of electricity systems [
3]. Over 42% of total electricity production was still from fossil fuels by 2021. The overall European wholesale electricity price rose from an average of €35 per megawatt-hour (MWh) in 2020 to above €500 per megawatt-hour (MWh) in 2022 [
4]. It has strained the electricity market as most of the traditional energy consumption in Europe relies on imports from Russia. Furthermore, the European wholesale electricity pricing mechanism is the marginal pricing method. The price depends on the final price of electricity according to the cost of production traded in the last unit, which in turn depends on the energy sources used in the electricity generation. The cost of electricity per unit from the renewable energy has fallen rapidly in recent years, but renewable energy generation cannot meet all the electricity demand in Europe. Thus, the rising cost of traditional fossil fuels, especially natural gas generation, has led to a recent surge in electricity prices in Europe [
5].
The rapid rise in electricity prices has increased the cost of production as well as the cost of living of households, not only boosting inflation in Europe but also causing a range of social problems. Especially in the season requiring heating, the demand for electricity will rise further. Renewable generation is affected by the current installed capacity and restricted by the climate condition with a high instability. For example, if the wind speed is relatively low, it cannot meet the minimum standard of wind power generation. In addition, the current limited energy storage equipment in Europe also further widens the electricity demand gap. Therefore, the fluctuation of European electricity markets, especially the price of electricity, has now attracted social attention.
The positive impact of fossil fuel prices as well as carbon emission prices on electricity prices has been verified in empirical studies in various countries [
6,
7,
8,
9]. Both fossil fuel and carbon emission allowances remain an important part of the cost of power generation worldwide at this stage. In recent years, with countries’ attention to climate change and the development and utilization of renewable energy, the scale and permeability of renewable generation have also played a significant negative impact on the electricity price [
10,
11,
12]. Most of the existing studies analyze and verify the one-way impact mechanism. However, the changes of electricity market and other related markets have a certain spillover effect. With the increase in electricity demand, the demand for traditional fossil fuel and renewable energy will also increase, promoting the rise of energy prices. Similarly, as traditional fossil fuel is still an important part of electricity generation, increased electricity demand will also drive the demand for carbon emissions allowances, thus raising the carbon price. In addition, when electricity prices rise rapidly, the high cost of electricity will also reduce the demand for electricity in the production sectors and households, thus reducing carbon emissions and having a negative impact on carbon prices. Therefore, in the context of violent fluctuations of the energy prices in Europe, it is important to study the dynamic interaction between the electricity markets and other related energy markets to better understand the price transmission mechanism and prevent the energy crisis in Europe.
At the same time, climate risks have an important impact on electricity demand and supply as the impact of extreme climate intensifies in recent years. On the one hand, extreme heat or extreme cold temperature will increase the cooling and heating demand, raising the overall demand for electricity, and it has a positive impact on the electricity price. The Green Deal has increased the power-to-heat in the district heating sector [
13]. On the other hand, both wind and solar electricity generation are dependent on climate conditions. Long-term low wind speed or cloudy days will reduce the renewable generation, thus increasing the electricity price. However, current studies of the impact of climate change or climate risks on the electricity market is still limited, and they mostly focus on the impact of cold freezing, ignoring the impact of other climate risks on electricity supply and demand. Therefore, this paper also introduces climate risk to the investigation of the spillover effect between electricity market and other markets, exploring the direct and indirect influence mechanism of different climate factors on electricity price.
The structure of the paper is given as follows. The second section will review the relevant literature and propose the innovation of this paper. The overall methodology and methods as well as the dataset and related indicators will be introduced in the third section. In the fourth section, the dynamic connectedness among electricity prices in the five European countries will be analyzed. Furthermore, the dynamic spillover effects among European electricity prices and fossil fuel prices, carbon prices, carbon emissions, and climate risk factors will be explored and discussed in the fifth section. Conclusions and suggestions will be given in the last section.
2. Literature Review
Many studies in the literature focused on the electricity price prediction in the short term, applying a large number of econometric models, machine learning or deep learning models to make a short-term prediction of the electricity price through the fluctuation characteristics of the electricity price itself [
14,
15,
16,
17,
18,
19,
20]. However, in these forecasts, less consideration is given to the impact of other energy prices, carbon emissions, and extreme weather on electricity prices and their inherent mechanisms. The electricity price prediction in the long term often takes into account the economic variables, supply and price of various energy sources as well as carbon emission-related policies [
12,
21,
22,
23].
With the continuous improvement of the electricity market mechanism, the degree of marketization and openness has been strengthened. The linkage between electricity markets in different regions and other traditional energy as well as renewable energy markets is strengthening, which has also attracted extensive attention from the academic community.
On the transmission relation of electricity prices in different regions, Menezes et al. investigated associations between spot prices from the British, French and Nordpool markets with those in connected electricity markets and fuel input prices and found that British electricity spot prices are associated with fuel prices and not with price developments in connected markets, while the opposite is observed in the French and Nordpool day-ahead markets [
24]. Keles et al. examined the interdependencies between the Swiss electricity market and those of neighboring countries and found that the Swiss electricity price correlated strongly with the German electricity price in summer, while it tends to follow the French electricity price in winter [
25].
As for the relationship between electricity price and traditional energy prices, a lot of research focuses on the impact of oil price, natural gas price and coal price on electricity price. Emery and Liu analyzed the relationship between electricity futures prices and natural gas futures prices and found that the daily settlement prices of New York Mercantile Exchange’s (NYMEX’s) California–Oregon Border (COB) and Palo Verde (PV) electricity futures contracts are cointegrated with the prices of its natural gas futures contract [
6]. Nakajima and Hamori tested the Granger causality-in-mean and in-variance among electricity prices, crude oil prices and yen-to-US-dollar exchange rates in Japan and found that although the exchange rates and oil prices influenced power generation costs, the Granger causality from neither the exchange market nor the oil market to the power market can be found [
26]. Gil-Alana et al. conducted a fractional integration and cointegration study, and the results showed that the oil price and interest rate had significant positive effects on the electricity prices in Kenya [
7]. Ohler et al. investigated the influence of fuel price volatility on electricity price and found the cola and natural gas costed Granger causality electricity prices for industrial and commercial customers in US states [
9]. Kristjanpoller and Minutolo applied a multi-fractal asymmetric detrended cross-correlation analysis to analyze the presence and asymmetry of the cross-correlations between the price of electricity in U.S. with respect to the crude oil and natural gas markets and found that the cross-correlation is higher in the case of oil and electricity pairs than the natural gas pairs [
27].
Renewable energy also has a certain impact on electricity price. However, due to the lack of indicators for renewable energy prices, existing studies have mostly discussed the impact on electricity price from the perspective of renewable energy production and penetration. Trujillo-Baute et al. analyzed the degree of influence of RES-E promotion costs on the evolution of electricity price in EU member states, and the results showed that the impact of renewable energy promotion costs on retail electricity prices is positive and statistically significant, although relatively small [
10]. Dong et al. studied the impact of penetration of renewable energy on electricity price and found that electricity price was more stable in Sweden as hydropower is a more stable energy source, while in Danshi price areas, the volatility of electricity prices is clearly affected by wind power [
28]. Rowińska et al. introduced a four-factor arithmetic model including deterministic seasonality and trend function, which are both short- and long-term stochastic components for electricity baseload spot prices in Germany and Austria, and the empirical results showed that taking into account the impact of the wind energy generation on the prices improves the goodness of fit [
11]. Tselika employed the quantiles via moments (MMQR) method to investigate the impact of intermittent renewable generation on the distribution of electricity price and found that the wind generation increased the occurrence of price fluctuations for low demand in both Denmark and German [
29]. Schönige and Morawetz studied the influence of renewable production on electricity spot prices in European countries and confirm a U-shaped relationship between the share of renewable electricity production and price variance in seven countries while the minimum price variance for most countries is found to be between 10% and 40% [
30].
With the emergence of Emission Trading Systems, carbon price, as an important cost of electricity, also has a certain impact on electricity price. Freitas and Silva evaluated the influence of CO2 opportunity cost on the Spanish electricity under Phase II and III of the EU ETS and found that there were not only long-run equilibrium relations but also short-run interactions between the electricity price and the fuel and carbon price [
31]. Woo et al. quantified the effect of California’s CO2 cap-and-trade program on the electricity prices in the western US, and the results showed that a
$1/metric ton increase in California’s CO2 prices is estimated to have increased the electricity price [
32]. Peña and Rodríguez studied the impact of renewables and other fundamental determinants on the electricity price in ten EU countries and found that the increase in production from renewables decreases wholesale electricity prices in all countries; however, it should promote electricity consumption [
33]. Mosquera-López and Nursimulu took into account nonlinearities in electricity price in Germany and found that in the future market of electricity, the main drivers are natural gas, coal and carbon price [
8]. Liu and Jin used a standard econometric approach analyzing the interactions between electricity, fossil fuel and carbon market prices in Guangdong, China, and they found that the electricity price was significantly and positively associated with coal price but had no significant relationship with carbon price and LNG price [
34]. Biber et al. used logistic regression to study the influence of energy source, fuel, and emission price on electricity price and found that the volatile generation of wind solar power will raise the likelihood of low and negative electricity prices, and a higher CO2 allowance price will reduce the likelihood of negative prices [
12].
Climate change has had a growing impact on human society in recent years; especially, extreme climate events have an important impact on energy demand, which in turn affects electricity prices. Santamouris et al. assessed the impact of the urban climate on the energy consumption of buildings in Athens and found that where the mean heat island intensity exceeded 10 °C, the peak electricity load for cooling purposes might be tripled [
35]. Taseska et al. used a MARKAL Macedonia model to identify the interactions between climate change and the energy demand in Macedonia and proposed the electricity production structure and energy demand of three different climate change cases [
36]. Mosquera-López et al. used an event study approach to study the unexpected spikes in electricity price and found that when a freezing event occurs, the average electricity price increases in the Nord Pool market [
37]. Jasiński presented a way of creating three new variables based on air temperature to be used in forecasts of electricity price and found the new model can reduce the MAPE by up to 15.3% [
38]. Guo et al. applied a TVP-VAR-SV model to analyze the nonlinear effects of climate policy uncertainty on global prices of crude oil and natural gas and found that responses of energy prices changed from positive to negative [
39]. Ozturk et al. used a multivariate stochastic volatility model and found that climate uncertainty indeed serves as a significant driver of price fluctuations in emissions prices [
40]. Lin et al. found that the extremely high price risk of electricity mainly occurred during severe icing intervals and was located in the regions away from major energy resources based on case studies [
41].
The existing studies in the literature have carried out a lot of research on the relationship between electricity markets, other related markets and climate risks, while most of them support that energy prices, carbon prices and climate risks have a significant impact on electricity prices. However, most of the existing studies focus solely on the one-way impact, and they are mostly limited to the relationship between a small number of markets. Few studies discuss the transmission relationship of electricity prices between regions while comprehensively exploring the relationship between electricity prices, energy prices, carbon prices and extreme climate risks from a systematic perspective. Therefore, this paper will build a double-layer system based on a spillover effect using daily data. In the first layer, the spillover relationship between electricity prices in five typical European countries will be explored, and then in the second layer, the spillover effects among electricity price, oil price, natural gas price, carbon prices, carbon emissions, and extreme climate will be proposed.
6. Conclusions
A double-layer system based on spillover effects using daily data of electricity prices as well as other related indicators is constructed in this paper while considering the impact of climate risks. The first layer system mainly considers the spillover effects among electricity prices in five European countries including the United Kingdom, Germany, Italy, Spain, and France; the second layer system mainly considers the spillover effects among electricity price, crude oil price, natural gas price, carbon price and carbon emission, as well as the climate risk factors including heating degree day and cooling degree day.
The results of the first layer system based on the electricity markets of different European countries show that there are certain spillover effects between electricity prices, among which the UK has the largest net directional connectedness, which is followed by Germany. The importance of the electricity market is mainly related to the status of the electricity trade. The dynamic analysis shows that the overall spillover index remains relatively stable, with only a temporary rise at the beginning of the Russia–Ukraine conflict.
The second layer system which focuses on the spillover effects among the electricity market and other energy-related markets considering climate risk shows that the electricity market is not only affected by crude oil, natural gas and carbon markets but also has a feedback effect to these markets. The results of the static analysis show that the price and systemic risk of the electricity market have a relatively larger net directional connectedness that is only smaller than carbon emission; that is, there is a significant spillover effect from the electricity market to other markets. The results of the dynamic analysis further indicate that there are spillover effects from the electricity market to other markets in most of the range. Especially since 2022, since the renewable energy generation cannot fully meet the electricity demand of Europe, the electricity market has a large spillover effect on carbon emission. At the same time, climate risks also have an important impact on the European energy system including the electricity market, especially the heating degree day. The demand for heating will affect the prices in various energy markets as well as carbon emission by driving energy consumption.
This paper systematically analyzes the spillover effects among the European electricity markets and those with other related energy markets while innovatively introducing climate risks into this system. On the one hand, it reveals the important role of the electricity market in the European energy market. On the other hand, it also confirms the significant impact of climate risks on energy prices. In the case of increasing geopolitical risks in the world and frequent energy crises, understanding the connectedness among various markets and the impact of climate risks has a certain guiding significance for better preventing market price risks and reasonable hedging the risks.