EUAs top €40 despite hint of speculator curbs

Despite an article by Bloomberg suggesting the European Commission would look to curb speculation in the EU ETS, EUAs climbed to a new record high at €40.25 today (12/02/2021) on another volatile day. 

Carbon broke through the 40 EUR mark for first time in early trading on Thursday before a late sell-off saw the price plunge more than €1.30 in the final 30 minutes. The sell-off, which continued this morning as EUAs dipped to €37.06, came immediately after the Bloomberg article was published. The source of the Bloomberg information is unknown and implementing such a policy would appear to be fraught with difficulty, but it was enough to spook the market.

According to Redshaw Advisors CEO, Louis Redshaw, implementing limits on registry holdings will stop banks and others buying huge volumes of spot and selling futures forward. This will have several impacts:

• Utilities will have to carry spot for forward hedges instead of buying futures. With their higher cost of borrowing (compared to the banks’) this will make EUAs more expensive for them and power prices higher (although probably not by very much). A new structure, whereby banks lend cash secured against utilities’ spot holdings will likely emerge.
• Speculators buy futures. Many of them can’t buy physical, for example for tax reasons. Nothing in this stops them from buying futures but banks won’t be selling many futures backed by spot, they will run out of capacity to do so. This will cause the spot/forward trade to widen, possibly to extreme levels. This protects industry to some extent as spot will be cheaper than forward.
• What happens to banks that have millions of tonnes of legacy spread trades on, no-one knows. It could cause a sudden and large widening of the carry trade.
• A new breed of small spot to forward financers will probably emerge that will take advantage of spot to forward trades up to the position limit. There would need to be a lot of them to make up for the same role that banks play now. 

On balance, once the above adjustments to market dynamics are established, the position rules, as currently rumoured, probably won’t have much impact. But some weird things could happen in between.

Redshaw added “Speculators typically take markets to where they need to go earlier than if they are left to their own devices. If the EU wants to limit speculators’ positions, either the price of carbon has to reach the long-term marginal abatement cost (MAC) (such that speculators won’t want to be long EUAs, and they may even want to be short them instead) or they have to limit participation in another way. Arguably €40 is on the way to the MAC and no-one in the analyst community thinks that the price shouldn’t be north of €40 over time. Sometimes speculators can get this wrong and uninformed or unethical speculators (e.g. those buying Gamestop ‘to teach wall street a lesson’) can cause things to be unnecessarily volatile. But, on balance, speculators are good for the efficiency of markets, for example they help things like liquidity and price discovery.”

The issue of speculative impacts on price and the prospects of position limits is not new, in fact Louis Redshaw suggested they were “inevitable” when discussing the topic at an EU ETS seminar in Barcelona hosted by analysts ICIS. You can read the Carbon Pulse round-up of the event here.

Summing up, Redshaw Added that “if the EU want to blame anyone for recent price rises, they might want to self-reflect. Allowing companies to borrow, then taking that right away at the end of the phase, excluding up to 60% of the EU economy from being able to participate in the EU ETS (thus drastically curtailing emissions reduction options that could be contributed by the wider economy) and cancelling nearly all of January’s auctions on a whim are all contributory factors to the current EUA price”.