Options Show Just How Badly Brexit May Hurt EU Carbon Market

  • Premium to buy put options advances faster than calls
  • U.K. seen ‘left out in the cold’ should trade talks fail

Brexit is sending prices in the European Union carbon market lower, and options traders expect it to get worse.

QuickTake The Cost of Carbon

Trade in options to sell permits in the world’s biggest climate market surged to the highest level since Jan. 21 on Monday, according to ICE Futures Europe data compiled by Bloomberg. The cost of bearish wagers on carbon has jumped to the highest in six months relative to bullish ones, the data show.

Allowances were already having a bad year before the U.K. electorate voted to leave the EU on June 23, which sent permits 19 percent lower through Wednesday. A Brexit raises the risk that the U.K. may be the first country to abandon the 11-year-old market, depriving it of the region’s second-biggest emitter. Allowance prices slumped 45 percent since the end of 2015 as lawmakers grapple with a permit glut that’s discouraging investment in clean technology.

“The options market indicates some traders may be fearful,” Anatoly Stolbov, an analyst at Virtuse Energy s.r.o. in Prague, said by phone. That reflects expected price falls if the U.K. leaves the market, a decision that could come as early as this year, he said.

Option Skew

Put options protecting against a 10 percent drop in benchmark Dec. carbon cost 8.9 points more than calls betting on a 10 percent rise on Friday, according to data compiled by Bloomberg. That was the widest spread since Dec. 1 for the price relationship known as skew. It was 8.6 points on Tuesday.

The EU program gives away or auctions allowances to about 13,000 factories, utilities and airlines, which need the permits to match their carbon dioxide output or pay fines. 

There’s a risk the future British decision on whether to stay in the EU market gets entangled in wider trade negotiations, said Trevor Sikorski, an analyst at Energy Aspects Ltd. in London.

“The U.K. could simply be left out in the cold,” if negotiations with the EU fail to reach a conclusion within two years of the start of divorce proceedings, Sikorski said Tuesday in an e-mailed note. “That means draining the market of liquidity and pushing the EU allowance inventory held by U.K. installations back into the market.”

The U.K. bought 48 million metric tons of allowances in 2014, according to an estimate by Iain Turner, an analyst at Exane BNP Paribas in London.

“With EU exit, this demand would be removed from the emissions-trading system, which would lead to softer prices, at least until the scheme could be tightened up,” Turner said June 24 in an e-mailed note.

Volume Doubles

The volume of put options almost doubled Monday to 5.8 million tons from the previous session, ICE Futures Europe data show. This month, 23.2 million tons have changed hands, the most since January. The put option with the most open interest has a strike price of 4 euros a ton.

December futures fell as much as 7.5 percent Wednesday to 4.34 euros ($4.82) a metric ton on ICE, the lowest intraday price since March 2014. They traded at 4.59 euros at 4:21 p.m. in London. Volume jumped 50 percent to 21.4 million tons, the most since Friday.

“Companies, faced by material Brexit-related uncertainty, are sensibly exploring their different risk-management alternatives,” said Louis Redshaw, founder of carbon-market consultants Redshaw Advisors in London, which trades on behalf of clients.

Put options are a useful tool for U.K. companies to use to protect the value of their asset if they expect they might have an oversupply of carbon allowances, Redshaw said by e-mail. “Recent options activity indicate that it’s actually happening.”

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