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EU Emissions Annex: Difference between revisions
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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). | 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. | 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. [[Cryptocurrency|Crypto]] is going through he same kind of thing. | ||
This means owning an {{euaprov|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. | This means owning an {{euaprov|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 price today — it won’t be today’s ''spot'' price of course; it will be today’s ''forward'' price, which will likely be higher — but we only settle the trade at maturity, when you need the Allowances for compliance purposes. | |||
What do we get out of striking this trade now? | |||
Well, the Seller achieves a guaranteed return on the EUA investment equal to its prevailing forward price, come what may in the future. If the arse falls out of the carbon market — can happen — even if the Eurocrats in Brussels ''give up on the carbon market altogether'' in the mean time — that risk is no longer mine. I just wait out the contract and deliver you these worthless certificates and you pay me the money. | |||
The Buyer gets that certainty of the carbon price, and has found a nice friendly lender to sit on the Allowance for the meantime. | |||