Booming trade for carbon as market grows more solid

Date: 20/01/05

Commodity trading might bring to mind an image of men in brightly coloured jackets making frantic gestures to one another across a trading floor.

The CO2 emissions market is a much more sedate affair. Those traders now telephone their counterparts to find out what price they are willing to deal at and all dealing is carried out electronically. At present there are between five and ten emissions transactions a day throughout Europe.

So who exactly is involved in trading CO2? Of the 12,000 installations covered by the emissions trading scheme (ETS), none is obliged to join the market at any particular time. The only requirement is that companies must surrender a certain number of allowances (one allowance = one tonne of CO2) to the European Commission at the end of April 2006. A company that has exceeded its allowance will have to buy back the difference on the open market and pay an additional fine of €40 per tonne exceeded.

The main players in the market are currently the big utilities and big industrial companies. These companies have been active on the fuel and energy markets for years, so slipping into the emissions markets is a relatively simple affair. Smaller firms must use a financial intermediary such as an investment bank to deal on their behalf. So this sector has been slower off the mark.

The number of market participants is also limited geographically. Companies in those countries where governments were swift to get their National Allocation Plan approved (see table next page) already know how much CO2 they can emit during 2005 and so can play the carbon trading game more confidently. Others have to sit back or estimate how much they will get.

Brokers believe that companies involved in ETS should jump in now. "We think prices will go up as the scheme develops so we're advising people to beat the rush," said one investment banker.

Certainly those already playing the game are keen to cover their backs. "It's all about risk management," says one trader who has been dealing in CO2 for his European electricity company for about six months. He sells forward electricity produced by his company while also buying coal forward to power the electricity plants. Now he also tries to buy emissions allowances forward to ensure he can buy enough at the right price.

"We need to be certain that we have enough allowances next year and when electricity and power prices are changing all the time this is only possible if we hedge our risks," he says. "We would be stupid to wait until next year to see how much we need to buy."

It is the combination of buyers and sellers which determines the price of CO2 at any time and expectations about emissions, the climate and all sorts of psychological factors influence these market players.

Oslo-based carbon market analysts Point Carbon say that since the official launch in January, in excess of 1.4 million tonnes have been traded in the broker market, which is more than 10% of the total volume recorded since April 2003. And the price has dropped from €8.40 to around €6.43 (on 13 January), which traders attribute to the unusually warm weather and the recent storms in Europe. Mild temperatures lead to less electricity consumption and greater rainfall fills up reservoirs used for hydropower.

"Scandinavian companies have been selling like mad over the last couple of weeks because they are very active in hydroenergy," says another trader, who estimates that the weather has double the market impact of allocation availability.

Brokers say the next big impact on carbon trading will come with the 'spot market', when traders can trade allowances instantly.

Although the official ETS launch was on 1 January, trading on the 'forward market' - where traders agree to deliver or to buy a certain number of tonnes of CO2 on a certain date at a certain price - kicked off in April 2003. It will continue until 28 February, when all companies should have an electronic 'account' holding their allowances. At that time dealers will be able to buy and sell CO2 instantly and what is known in the trade as a 'spot market' is likely to develop.

"That will attract more people to trade as the market will no longer be so risky. As we are not working on a credit basis it will be a more solid market," says one trader.

So far the price of CO2 has moved between a high of 13.20 euro/tonne in January 2004 and a low of 5.50 euro/tonne in May 2003.

Article explains the functioning of the EU's emissions trading scheme which was launched in January 2005 in an attempt to reduce the production of greenhouse gases.