Industrial companies are contemplating a shift in their approach by considering earlier purchases of carbon permits to hedge against future financial risks, as suggested by market participants and analysts. In 2014, emissions from industrial companies constituted 33% (596mtCO2e) of the total stationary installation EU emissions trading system, as per EU data. Traditionally, industrials have chosen to stay out of the market, sell excess permits when prices are deemed acceptable, or sell immediately after meeting compliance requirements, depending on their strategy and financial status. However, sectors such as steel, cement, and glass production may assume a more significant role in purchasing EU emissions allowances (EUAs) in the future.
Analysts’ forecasts indicate that the price of EUAs is expected to triple to €22/tCO2e by 2020, on average (see EDCM 12 May 2015). Consequently, industrials, even those already holding surplus permits, might opt to buy EUAs to safeguard themselves against future price exposure. “They might think it is better to purchase the allowances now at under €10/tCO2e, rather than at €20/tCO2e,” suggested an analyst from a trading house last month.
Moreover, there is uncertainty surrounding the number of free EUAs industrials will receive in the future. Many companies are allocated free EUAs to prevent carbon leakage, which refers to businesses relocating abroad to avoid climate law compliance costs. The European Union plans to revise the rules on free EUA allocation post-2020. A leaked European Commission impact assessment indicates that while free allocation is likely to continue, new regulations are under consideration (see EDCM 4 June 2015).
Borrowing Funds
Unlike utilities, industrials presently focus on spot market transactions. However, they may begin to adopt a longer-term perspective. Given the current low-interest rates, companies could borrow money at a low cost to purchase carbon permits and hedge against future increases in EUA prices. Jan Ahrens from ICIS analysts Tschach Solutions suggested that only financially stable companies are likely to afford this approach. For industrials to act, EUAs may need to break free from their current price inertia. “They will become more alarmed if prices move,” remarked Louis Redshaw from Redshaw Advisors on Monday. Throughout 2015, EUAs have ranged between €6.46 and €7.76/tCO2e, according to ICE Futures Europe.
Limited Selling
The carbon permit strategies of companies may differ based on their specific circumstances. However, it is evident that firms will be less willing to sell permits if they anticipate higher future costs for purchasing EUAs.
“The majority aren’t particularly interested in selling,” noted Redshaw on Monday. Only cash-strapped companies would sell permits to raise funds. In such cases, Ahrens cited a potential psychological threshold of €10/tCO2e to encourage sales. Certain sectors had previously accumulated significant surpluses of EUAs due to an excess allocation of permits.
While utilities constitute the largest sector in the EU emissions trading system, they are expected to reduce hedging in the future due to narrow power generation profit margins and stricter regulations (see EDCM 4 June 2015). Furthermore, speculators may exhibit reduced involvement due to decreased risk appetite.
