Volatility, confusion after EU emissions data published

London, 18 May: Prices for EU carbon dioxide (CO2) allowances once more surprised market participants this week, defying expectations that they would crash following the release by the European Commission of verified figures for 2005 emissions.

The data – released officially on Monday, but leaked on Friday – confirmed market expectations that the EU Emissions Trading Scheme is awash with surplus allowances. However EU allowance (EUA) prices rallied, due to a lack of supply in the market.

"There's a mismatch in supply and demand," says Gerhard Mulder, an emissions specialist in investment bank ABN Amro's commodity derivatives team. "Theoretically, the price should be 10 cents, but the supply is with industrial companies who only come to the market sporadically."

Prices for allowances for delivery in December 2006 began the week at €9.00/tonne ($11.52/tonne) of CO2. The price came under heavy selling pressure from speculators, but traders and brokers say that there were few natural sellers in the market.

"The length all came out of the market as it came down from €30/t," said one trader, who declined to be identified. EUA prices had fallen from their heights in mid-April, as the first indications came on 25 April from member states that companies covered by the trading scheme, which began operating last year, had emitted significantly less than they had expected.

From 2-11 May, the market traded in the low teens, awaiting the official publication of figures from the European Commission, due on Monday. However, the figures were inadvertently posted on the Commission website last Friday, leading to the price falling by the close to €9.30.

These figures showed an oversupply of 44 million tonnes of allowances in the first year of the scheme – whereas the market had expected the system to be short of allowances. Many analysts believe that this is an understatement of the oversupply.

Because EUAs can't be carried from the first phase of the scheme into the second, which begins in 2008, their price will theoretically fall to zero if there is seen to be more allowances than likely emissions over the first phase.

Analysts say that this is now the case and, as such, speculators attempted to drive the price down further. However, with few sellers in the market, these speculators were forced to cover their short positions, driving the price up to close at €15.10/t on Monday. The next day, EUAs traded between €21.50 and €14.90, on heavy volume.

Traders gave a number of reasons for the apparent dislocation between the price and supply and demand fundamentals. Most industrial installations covered by the scheme are not active traders, and may only buy or sell allowances once or twice a year. Equally, announcements from a number of governments suggested that they may move to mop up surplus allowances. And many are only likely to sell allowances when it is clear they have an excess.

The publication of the 2005 data has led to sustained criticism from environmentalists, accusing industry and government of colluding to undermine the scheme. The Commission has defended its role, noting that this is the first time verified CO2 data has been collected in most of Europe, and insisting that targets will be tighter for the second phase of the scheme. Member states have until the end of June to submit their plans for 2008-12 emissions targets, which the Commission has said it will scrutinise carefully.

See www.carbon-financeonline.com for in-depth coverage of developments in the carbon market.