EU Emissions Annex: Difference between revisions
Amwelladmin (talk | contribs) No edit summary |
Amwelladmin (talk | contribs) No edit summary |
||
| (One intermediate revision by the same user not shown) | |||
| Line 11: | Line 11: | ||
A forward contract is intended to get a risk off your books. Why now, rather than later? Well — the person needing an Allowance for compliance purposes only needs it at the end of a compliance period. Until then, it clutters up the balance sheet, costing money. (If you buy it, you have to pay for it. This uses capital you might rather use for something else.) On the other hand, the market price of Allowances tends to rise, in part by deliberate intervening design on the part of the EU ETS. So compliance users have conflicting emotions: on one hand, I would like to lock in the price, now, of an Allowance, so I am not at the mercy of the rapacious market; on the other, ideally I would rather not fork over any money until I actually need the Allowance. | A forward contract is intended to get a risk off your books. Why now, rather than later? Well — the person needing an Allowance for compliance purposes only needs it at the end of a compliance period. Until then, it clutters up the balance sheet, costing money. (If you buy it, you have to pay for it. This uses capital you might rather use for something else.) On the other hand, the market price of Allowances tends to rise, in part by deliberate intervening design on the part of the EU ETS. So compliance users have conflicting emotions: on one hand, I would like to lock in the price, now, of an Allowance, so I am not at the mercy of the rapacious market; on the other, ideally I would rather not fork over any money until I actually need the Allowance. | ||
The solution: a forward contract. You strike your | The solution: a [[forward contract]]. You strike your trade today — it won’t be today’s ''spot'' price of course; it will be today’s ''forward'' price, which in a [[contango]] market will be higher — but you only ''settle'' the trade — pay for it, and get the goods — at maturity, when you actually need the {{euaprov|Allowances}}. | ||
What do we get out of striking this trade now? | What do we get out of striking this trade now? | ||
Well, | Well, Seller achieves a guaranteed return on its investment: The return over the term of the period is {{font|helvetica}}''forward price - spot price * Number of Allowances''</span> which, articulated in another way, is a fixed rate of return. | ||
The | The Seller gets its return should the arse falls out of the carbon market — can happen — or even if the Eurocrats in Brussels ''give up on the carbon market altogether'' in the mean time — that is the risk that buyer assumes by entering into the forward purchase. | ||
Buyer has all “Allowance” risk; Seller just has to pony up the Allowances. | |||
Which does make you wonder what the divers [[Carbon Squad]]s had in mind when they contrived the “[[Then I woke up and it was all a dream]]” method of resolving settlement disruptions. | |||
{{Sa}} | |||
*[[Forward contract]] | |||
*[[Then I woke up and it was all a dream - Emissions Annex Provision|Then I woke up and it was all a dream]] | |||
Latest revision as of 12:31, 7 November 2023
|
EU Emissions Allowance Transaction Annex to the 2005 ISDA Commodity Definitions
|
Some thoughts on what emissions trading documents should do, given the idiosyncrasies of the European compliance carbon market.
It’s entirely dependent on regulation
The compliance emissions business is entirely a function of prevailing regulation: an emissions allowance is a regulatory derivative (compare with the voluntary carbon market, which is more like a fashionable opinion derivative). Unlike any other asset, its “issuer” has virtually unlimited ability to change the terms of the market — including by abandoning it altogether — without any sanction. (Central banks can freely restructure their debt, but do it on pain of censure by the bond and credit derivative markets).
Not only can the regulators change the terms of the EU Trading Scheme, but they do. It has structural changes — compliance phases — and the regulators also consider ad hoc changes from time to time, to shut down the inevitable speculative loopholery that comes from a new and inchoate asset class. Crypto is going through he same kind of thing.
This means owning an Allowance is a fraught occupation. And financing an Allowance owned by someone else, is an even more fraught occupation. Hence, the terms on which one buys and sells — and sells forward — are import to the stability of the market.
The point of a forward sale is ... to sell
A forward contract is intended to get a risk off your books. Why now, rather than later? Well — the person needing an Allowance for compliance purposes only needs it at the end of a compliance period. Until then, it clutters up the balance sheet, costing money. (If you buy it, you have to pay for it. This uses capital you might rather use for something else.) On the other hand, the market price of Allowances tends to rise, in part by deliberate intervening design on the part of the EU ETS. So compliance users have conflicting emotions: on one hand, I would like to lock in the price, now, of an Allowance, so I am not at the mercy of the rapacious market; on the other, ideally I would rather not fork over any money until I actually need the Allowance.
The solution: a forward contract. You strike your trade today — it won’t be today’s spot price of course; it will be today’s forward price, which in a contango market will be higher — but you only settle the trade — pay for it, and get the goods — at maturity, when you actually need the Allowances.
What do we get out of striking this trade now?
Well, Seller achieves a guaranteed return on its investment: The return over the term of the period is forward price - spot price * Number of Allowances which, articulated in another way, is a fixed rate of return.
The Seller gets its return should the arse falls out of the carbon market — can happen — or even if the Eurocrats in Brussels give up on the carbon market altogether in the mean time — that is the risk that buyer assumes by entering into the forward purchase.
Buyer has all “Allowance” risk; Seller just has to pony up the Allowances.
Which does make you wonder what the divers Carbon Squads had in mind when they contrived the “Then I woke up and it was all a dream” method of resolving settlement disruptions.