Secondary market activity decreases as participants anticipate further policy direction

June 14, 2014 by CaliforniaCarbon.info

CaliforniaCarbon.info, June 14, 2014: After over 6 million California carbon allowances (CCAs) were exchanged on the InterContinental Exchange (ICE) alone in the two weeks following May’s cap-and-trade auction, this week saw a quietening in the secondary market, both in terms of the total weekly traded volumes, and of daily price fluctuations.

This week, only 210,000 CCAs were traded via ICE, all of them V2014s delivering either within the month or in December 2014. This is 6.1% of the 3.49 million traded last week, although the presence of spread trades contributed significantly to that total.

Prices on ICE as well as those reported by the brokerages fell slightly between last Friday and Tuesday, before exhibiting little or no movement for the rest of the week. The current benchmark (V14 Dec 14) closed last week at $11.89, settled at $11.84 this Monday, and traded at $11.80 for the rest of the week. No actual trades happened for any other vintage, but the price trend was similar. The V16 Dec 15 dropped from $12.25 to $12.18 from Monday to Tuesday, while the V17 Dec 16 fell from $12.95 to $12.85. This is the first time since the auction that all vintage-delivery combinations have maintained the same price levels for three successive days.

The same contracts going OTC moved in a similar pattern. The V14 Dec 14 shed four cents on Monday ($11.90 to $11.86) and held level thereafter, the V16 Dec 15 moved from $12.31 to $12.29 to $12.26 Friday through Tuesday, while the V17 Dec 16 steadied at $12.75. The spot price lose eight cents in two trading days to close Tuesday at $11.65. It is interesting that as many as two brokerages failed to report prices on Thursday and Friday.

While a drop-off in secondary market activity a couple of weeks after auction settlement has historically been the case, on this occasion there may be additional explanations. Firstly, participants may be inclined to wait for the ongoing Clean Harbors investigation to be concluded, as its outcomes would condition market assessment of invalidation risk going forwards. Clean Harbors is the first invalidation review conducted by ARB, and the market will be looking to see how severe the repercussions, if any, of regulatory non-compliance might be. In addition to highlighting the uncertainty over  the size of the negative premium that should be attributed to invalidation, the investigation also has had the practical effect of embargoing the trade of all 4.46 million offsets generated from activities which used Clean Harbors, which have been transferred into an ARB jurisdictional holding account. 4.46 million is 40.7% of the 10.9 million credits issued so far, and the effect has been a suspension in secondary offset trading, with brokers beginning to report ‘N.A.’ for CCO bid prices. Participants looking to include offsets in their compliance strategies may be putting procurement on hold until they are certain whether they need to change these strategies based on developments with Clean Harbors.

Secondly, although there was an initial optimism stemming from the fact that the Environmental Protection Agency’s (EPA’s) Clean Power Plan for regulating emissions from electrical generation units would permit cap and trade as a compliance pathway, closer consideration of the details of the plan have raised questions over whether several aspects of the design of California program might prove problematic for demonstrating the reductions EPA wants. Firstly, the regulation is expected to mandate 30 percent emission intensity reductions from the power sector by 2030, and it is unclear how a system-wide program can ensure this is achieved. One solution which has been suggested is to create two sub-programs for covered and non-covered facilities under the EPA regulation, and only allow unilateral secondary trading to occur (i.e. non-power compliance entities can buy allowances earmarked for the EPA-regulated power entities, but not the other way round). Secondly, EPA will not accept out-of-sector reductions to count towards the target, meaning offsets can only be used in addition to the mandated 30 percent reduction. On both fronts, compliance entities may be tempted to adopt a wait-and-see approach until a bit more certainty emerges.

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

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