CARB has also outperformed these oil ETCs over a 3-year horizon. Trading volumes are also on the up. In contrast to credit markets, carbon market liquidity continued to trend up through the credit crisis with 30 day average daily EUA futures volumes increasing 338 per cent between 1 September 2008 and 14 May 2009 with trading averaging €342 million/day in the three months to May 14 (Figure Two). The inclusion of new sectors in the trading system is helping to boost trading. EUA selling by cash strapped firms has provided a further short run impetus to trade.
Figure One
Figure Two
Emissions (and by implication EUA demand) are a by-product of production, and are hence related to the level of manufacturing activity. EUA prices are also correlated with energy prices, energy being a key input and emissions a key output of the same production process (Figure Three). Manufacturing activity has consolidated across number of major producers recently, including Europe. If sustained, this consolidation in activity could help provide a floor to EUA demand (Figure Four). Note that roll yields (returns from rolling expiring futures) play a much smaller role in CARB returns than near-dated oil futures. The reduced impact of roll yields, together with carbon’s correlation to broader energy markets, has seen carbon act as a leveraged play on oil markets recently (Figure Five).
Figure Three
Figure Four
Figure Five
On the supply side, EU member states have agreed to reduce GHG emissions by 20-30 per cent versus. 1990 levels by 2020 – with further cuts in allowances possible beyond 2012. These regional reductions will continue regardless of the outcome from post-Kyoto discussions on international emission cuts. This target will result in an annually declining emissions cap as the European Commission is looking to decrease allowances over time to encourage firms to increase production efficiency. Annual allowance allocation is also set to become more competitive, with allowances to large scale users such as electricity generators being increasingly auctioned from 2013. Other sectors are also due for inclusion in coming years, including aviation from 2012, increasing the pool of prospective end users of EUAs and EUA liquidity. Furthermore, with current EUA prices low and credit conditions tight, investment in emission reductions at the company level is likely to fall sharply in the near-term. The long-term implication is higher emissions per unit of output in the future, and stronger demand for EUAs when the economic cycle turns.
Although relatively new, the EU carbon market has traded in line with other markets through the credit crisis – and liquidity has continued to grow. Already EUAs have acted as a leveraged play on oil prices, outperforming short-dated oil returns as the oil curve shifted into contango last September. Carbon is likely to emerge as a more dominant energy benchmark in the future given its correlation to other energy and industrial markets. Its unique term structure, supply, and growth characteristics could see it develop further as an asset class beyond its current industrial investor base.
Carbon is available as a listed investment vehicle in Europe for the first time via ETFS Carbon (CARB), listed on the London Stock Exchange.
Daniel Wills is senior analyst at ETF Securities. The views expressed here are his own. No recommendation is inferred.