Speculators behind strong auction demand, traders say
Auction demand has proven strong in January, a circumstance that traders attributed a higher involvement of financial institutions as carry trade regained attractiveness.
58.4m spot EUAs have been auctioned on the European Energy Exchange (EEX) by EU governments in January, with total bids equalling 207.8m EUAs. The cover ratio – the ratio between the volume on offer and the volume bid – has outturned above 3 in every single auction held on EEX save but one, with a high of 4.64 and a low of 2.72. It has been on average 3.56, compared with an annual average of 3.30 over the whole 2013.
The data refer to auctions held on the EU common platform and auctions held on behalf of Germany and Poland on their separate platforms.
Traders pointed to a higher involvement of banks and funds as the reason for strong auction demand in January.
As the product sold at auctions is spot EUAs, auction buyers need to have an immediate availability of cash. Carry trade sees companies with cash to invest buying spot EU allowances (EUAs) and simultaneously selling futures to lock in the premium future delivery holds over the spot market. With the carbon curve in contango, the strategy is well established in the market and is usually done by banks or investment firms ( see EDCM 22 November 2013 ).
“I think the majority [of auction demand] is carry trade – banks and funds. The small part is end users,” said one source at a trading house.
The premium of the front year to the spot is typically at its highest in January, when the delivery of the two contracts is most distant, and progressively narrows throughout the year.
Front-year/spot carry trade lost attractiveness in the second part of 2013 as the delivery of the two contracts got closer. The spread spot-Dec ‘13 dropped from €0.20/tonne of CO2 equivalent (tCO2e) on 2 January 2013 to zero on 29 November 2013.
The fact that in parallel to the narrowing of the spread the share of speculators in auction purchases decreased ( see EDCM 21 January 2014 ), was considered more than a coincidence.
With the spread reopening in January and currently valued at €0.10/tCO2e, carry trade became attractive again.
“They will want to do more [carry trade] now when spread at widest,” the source added.
One source at a power generator pointed to a different reason why financials could be buying in auctions, as free allocation is still pending.
“I think some people are getting nervous not having the free allocation and are going asking banks to cover them buying spot,” he said.
In November, of the 58 companies eligible to bid in EEX auctions, 38 were operators with caps under the EU Emissions Trading System (ETS), nine were investment firms and 7 were credit institutions. The other four were persons exempt from the authorisation requirements in EU financial law. Silvia Molteni
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