European carbon

Published at 11:30 8 Oct 2018 by . Last edited 15:12 5 Nov 2018.

The EUA market may have settled into a 20-22 €/t range over the last few weeks, but there has been a notable widening of the contango across the curve. The implied cost of carry for the Dec-18–Dec-20 spread has gone from 1.8% per annum (p.a.) at the start of September to 3.5% p.a. at Friday’s close (5 October). The contango was even wider on the Dec-18–Dec-21 spread, at an implied 4.1% p.a. at Friday close. The widening of the contango suggests that the so-called ‘repo’, an arbitrage trade on the cost of carry, should be at levels tempting financials and funds into this low-risk trade. With a repo, a market participant buys the front end (Dec-18) and sells a further-dated contract (Dec-20, for example), locking in an implied rate of interest. So long as the participant’s cost of funding is lower than the cost of carry on the curve, it is a profitable trade. While this looks like a no-risk trade, there are some tail risks that market participants will consider. The main one we tend to hear is a concern over what happens if the EU ETS was to be wound up before the expiry of the further-dated leg of the trade. While that event would obviously render the trade worthless, the risk is a tail probability event which we currently assess as having less than a 1% chance of happening. There is extremely little political will among the European Commission or European Parliament to end the EU ETS. Even if that were to occur, such a big change to EU policy would take around two years to get through the EU legislative processes. And even if that process started now, it would be unlikely to be agreed and implemented before the expiry of the Dec-20 contract. Given such a low risk, we expect to see more capital coming into the repo trade, which should narrow the contango in the timespreads.    

Fig 1:     EUA cost of carry, €/t Fig 2:     EUA rates of funding, % per annum
Source: Reuters, Energy Aspects Source: Reuters, Energy Aspects

  

Log in to download

Other Carbon weekly publications

European carbon

Published 4 days ago

2019-04-15 Emissions - Carbon weekly - European carbon cover
Next week's edition of Carbon weekly will be published on Tuesday 23 April, owing to the UK bank..

Read more

European carbon

Published 1 week ago

2019-04-08 Emissions - Carbon weekly - European carbon cover
EUA prices gapped up in the second half of last week despite 2018 verified emissions coming in at..

Read more

European carbon

Published 2 weeks ago

2019-04-01 Emissions - Carbon weekly - European carbon cover
1 April always involves the release of verified emissions data for EU installations for the previ..

Read more

European carbon

Published 3 weeks ago

2019-03-25 Emissions - Carbon weekly - European carbon cover
It was another eventful week in the UK’s Brexit saga, which helped further soften EUA prices to 2..

Read more

European carbon

Published 1 month ago

2019-03-18 Emissions - Carbon weekly - European carbon cover
Though we are loath to let our weekly become a Brexit blog, we cannot help but flag what will be..

Read more