Does natural gas fuel price cause system marginal price, vice-versa, or neither? A causality analysis

Faced with ever-increasing demand for electricity, policymakers in South Korea plan to introduce a new tariff regime that properly reflects the varying costs of generation in the wholesale power market. Since it is crucial to have supporting empirical evidence for this regime, this study attempts to investigate the nature of long- and short-run causality between LNG (Liquefied Natural Gas) fuel price for generation and wholesale power price in Korea. To this end, we apply the time-series techniques of unit-root and co-integration tests, as well as error-correction modeling using monthly data from April 2001 to January 2011. The results indicate that there is a unidirectional causal relationship running from LNG fuel price to wholesale electricity price in both the short- and the long-run. Strong causality in the same direction is also detected. This means that an increase in LNG fuel price directly affects wholesale power price. Therefore, Korean policymakers should take more consideration of LNG fuel price for generation when they design and implement any future retail indexation tariff regime.