Major hedge on auction day; V17s emerge on exchange market

May 18, 2014 by CaliforniaCarbon.info

CaliforniaCarbon.info, May 18, 2014: During the week of the seventh cap-and-trade auction (Fri, May 16), a total of 5,372,000 allowances (CCAs) were contracted on the InterContinental Exchange (ICE), the primary futures exchange in the market. This was the highest weekly total since the week beginning 7th April, and brought to an end a fortnight of relative inactivity during which less than 2 million CCAs were exchanged.

There were several contributing factors to this jump in exchanged totals. The most obvious was a pair of hedges, for exactly 1.5 million V2016 CCAs each, delivering in December 2015 and June 2016 respectively, that were struck on Friday, the day of the auction. This was likely an attempt to capitalise on a moderate drop in prices in the second half of the week, which saw the V16 Dec 2015 lose four cents Wednesday to Friday when it traded at $12.18, and the V16 Jun 2016 lose five cents Wednesday to Friday when it traded at $12.40. These prices approach the lowest  that the market has seen since the immediate aftermath of the previous auction in February. It is not known how these hedges may have interacted with possible bid strategies at the auction.

These were not the only hedges that took place during the week. The V2017, newly introduced on ICE alongside the V2018, was the subject of a few smaller hedges. A delivery for 200,000 in December 2016 was contracted on Tuesday, and another for 300,000 contracted on Friday. A contract for a quarter-million V2017s delivering in December 2015 went through Thursday, the same day on which a similar contract for V2016s was struck. The market appeared to take more decisive futures positions in light of auction bid strategies that were being firmed up.

There was also some activity for near-term deliveries, much of which may have involved allowances which entities expect to come into their possession through the auction. 600,000 V2017s delivering in either May or June this year were contracted through the week, as were 285,000 V2014s. 9,260,000 V2017s were available for auction, as were 16,948,080 V2014s. Once auction results are announced this Wednesday, May 21, winning bidders will have up to seven days to make payment, after which the instruments will be transferred into their CITSS accounts. If payment is completed quickly, it is possible that auction allowances may be transferred, once from the auction account, and twice between the CITSS accounts of entities that have participated in a bilateral trade, within the month of May.

The amount of V2014 allowances contracted for near-term delivery on ICE immediately prior to the auction is lower in May than in February, when the figure stood at 771,000. This could suggest that fewer entities predict a major secondary market price reaction to the auction, and hence see less of an incentive to pre-arrange a fixed-price contract. In February, the benchmark contract traded at $12.22 on ICE on auction day, some $0.88 above the primary floor. On this occasion, it traded at $11.73, merely $0.39 above the primary floor.

In some ways, it seems as if the anticipated reaction to the auction has already been priced into the secondary market during the week. As mentioned above, prices fell for most near-term vintage-delivery combinations. The current benchmark lost eight cents during the second half of the week, dropping from $11.81 to $11.73. The forward benchmark witnessed a sustained, gradual seven-cent fall through the week.

As we have previously reported, this is a bearish market in which no shortage is expected in the first compliance period (CP1). Even Tuesday’s confirmation of a two percent rise in total statewide emissions (confirming the two percent rise in covered emissions reported by the various facilities last November) failed to produce any upward price motion. The adjustments to the industrial assistance factors confirmed at the end of April may serve to further lengthen the market going into CP2. The signs from the secondary market in the past week point to an auction that clears close to or at the defined price floor of $11.34.

Click here to view secondary market prices in more detail

Click here to download the results of a pre-auction survey which we conducted earlier this month

For further information regarding this article, please write to contact@californiacarbon.info.

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