Carbon Swings Hit Year High Amid Supply Concern

European Union emission permit prices are swinging in the widest range since January 2012, encouraging speculation that may be exacerbating losses amid a supply glut.

Thirty-day historical volatility for December carbon allowances rose to 78 percent yesterday on ICE Futures Europe in London, the highest in a year, according to data compiled by Bloomberg. The benchmark contract has fallen in 18 of the past 22 sessions and slid 20 percent last week, its biggest drop since the five days through June 24.

The euro area’s second recession since 2008 has damped industrial demand for permits, driving their price to record lows as volatility surged. A proposal by the EU regulator to cut supply is facing opposition from some members of the European Parliament, increasing uncertainty. The 54 billion-euro ($73 billion) market is at risk of “total collapse,” Bas Eickhout, a Dutch member of the Brussels-based parliament, said Jan. 22.

“There is an immediate risk that prices could fall even further if the market’s perception that the EU cannot implement a rescue plan for the market continues,” Paolo Coghe, a senior European power, coal and carbon analyst at Societe Generale SA, said Jan. 28 by phone from Paris. “When the opportunity to sell presents itself, the market jumps on it.”

The region’s emissions trading system, or ETS, imposes pollution caps on about 12,000 installations owned by manufacturers and power plants. Those so-called compliance buyers purchase the credits to conform with limits on greenhouse gases, with each permit allowing a company to emit one metric ton of carbon dioxide.

Slowing Output

As industrial output slowed, regulators have had little room to curb the decline in prices because there is no mechanism for cutting supply.

December EU permits dropped 40 percent this year and fell to a record 2.81 euros a metric ton on Jan. 24. The contract traded at 3.97 euros a ton at 1:04 p.m. in London. Prices moved in a 96 cent range today, compared with a daily average of 49 cents last month and 39 cents for the front-year contract in January 2012.

Permits tumbled as much as 36 percent to 2.81 euros a ton in a minute on Jan. 24 after the European Parliament’s industry committee rejected a measure aimed at allowing regulators to adjust the permit supply. The parliament’s environment committee will meet on Feb. 19 to discuss and vote on the proposal.

Daily trading of all carbon futures contracts on ICE on Jan. 24 was 53 million tons, the most since Dec. 11 and almost seven times as much as on Jan. 2. The increase isn’t reflected in open interest, which rose 6.6 percent to 980 million tons from Jan. 2 to Jan. 24.

Speculative Traders

“That’s a strong sign that there are more speculative traders than compliance buyers,” Coghe said. “Compliance buyers have a much lower tendency to trade in and out.”

The number of available permits surpassed industrial and utility demand by about 1.6 billion at the end of last year, Kathrin Goretzki, an analyst at UniCredit Bank AG in Munich, said in a Jan. 29 report. That’s the most ever and equivalent to about 80 percent of a year’s supply, according to Bloomberg New Energy Finance data.

A majority of EU governments will probably vote in favor of the so-called backloading plan, with some countries signaling conditional support or urging more ambitious measures, according to three EU officials. The proposal is still short of qualified majority in the EU ballot system and votes by seven countries including Germany holds the key to the decision, they said. The other six countries are Portugal, Hungary, Malta, who are undecided; and Cyprus, Greece and Czech Rep, which voiced concerns. Poland opposes it.

Cutting Forecast

The commission’s plan is “marginally” more likely to pass than fail, Trevor Sikorski, Barclays Plc’s director of European energy markets research in London, said Jan. 23 in a research note. Prices will average 5.5 euros in 2013, he said, cutting an earlier forecast by 35 percent. The contract will fall to 3 euros should the proposal fail, he said. Nations may block the proposal should Germany abstain from voting, he said yesterday.

Postponing the sales of 900 million permits from 2013-2015 to 2019-2020 is not sufficient to save the market and should be followed by a deeper overhaul of the EU emissions trading system, according to Eickhout. It should include a permanent removal of at least 1.4 billion allowances and accelerate the pace of carbon reductions in the ETS to 2.5 percent per year from the current 1.74 percent, he said in an e-mailed statement.

Short Sellers

“Failure to deliver a permanent solution will mean the emissions trading scheme will continue to fail in its purpose of delivering domestic emissions reductions and stimulating investment in green technologies,” he said.

Declines in prices since early December have worsened as traders carried out short sales, in which they borrow permits from companies and sell them in order to buy them back at a cheaper price, Coghe said.

One sign of bearish speculation is rising volume in options to buy permits at prices far above current levels, purchased by traders to offset short positions, Coghe said. Last week, more than 10 million options to buy at 7 euros and above changed hands on ICE compared with 5.5 million tons a week earlier.

“Traders will be able to short the market and benefit from volatility, while compliance players may not because they have to hold on to their permits,” Matthew Gray, an analyst at Jefferies Group Inc. in London, said Jan. 29 by e-mail.

Factories and power stations must surrender permits matching their emissions from the previous calendar year no later than April 31 every year.

For compliance buyers, the best course of action amid spiraling speculation may be to take a view on when prices will reach a bottom, SocGen’s Coghe said.

“You could simply decide not to buy until you think the price won’t drop any further,” he said. “You would have to convince risk managers to allow you to do that.”

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