US: Auction could rise because of short position, cost of capital

Market participants are anticipating the upcoming Air Resources Board (ARB) auction to clear at a slightly higher level than the previous auction because of bid support on the secondary market and a more mature market outlook.

The ARB, the cap-and-trade regulator, will auction off 77m current vintage allowances and 10.4m Vintage 2018 allowances on 21 May. The current auction includes nearly 2m Vintage 2013 allowances, which can be used for the upcoming compliance deadline. The results will be published at 12:00 Pacific time on 28 May.

Many market participants are expecting a clearing price between the $12.25-12.40/tCO2e for current vintage allowances, but they are not expecting a noticeable change in the future vintage sale, which cleared at the $12.10/tCO2e floor price in February. Traders do not think the inclusion of Vintage 2013 allowances will alter the market.

Market participants said the clearing price could rise $0.06-0.09/tCO2e based purely on the cost of capital rates that some entities are factoring into bid strategies. Previously, the market did not appear to factor those rates into auction strategies, resulting in a stagnate auction clearing price for most of last year.

“The market seems a bit more savvy now with more players,” a trader at a trading house said of the May auction.

Fuel and natural gas suppliers joined the programme this year, and they are likely to be the biggest buyers of California carbon allowances (CCAs) at auction. Some of those entities are more familiar with commodity markets, including cap-and-trade programmes.

Some traders also believe companies, including fuel suppliers, could be short of allowances going into the auction. The ARB does not release compliance entities’ positions so it is not possible to confirm that theory.

However, fuel supplier Tesoro has not taken part in an auction since November 2013, while most of the other large fuel sector entities have been active in the auctions. Tesoro emitted more than 39m tCO2e in 2013 from fuel sales alone, according to ARB data.

Traders and brokers attributed bid support and increased buying in recent weeks to an entity or entities covering short positions in the secondary market ahead of the auction. Data from the Intercontinental Exchange shows a noticeable uptick in weekly volume over the past two weeks, rising from 2m in late April to 11.5m in mid-May.

“There is continued buying in the market,” a second trader said of the behaviour. “It looks like someone is filling [compliance needs]. There are probably more shortish participants than there were in the last auction.”

Some market participants cautioned that the supply-demand balance of the market may not support any significant increase over the previous auction price of $12.21/tCO2e. Those entities believed the market would settle close to that market for the May auction.

A large fuel supplier trader said he did not see a reason for the market to rise significantly above $12.21/tCO2e, pointing to the increased volumes at auction.

The front-month Vintage 2015 had declined slightly to $12.53/tCO2e on Wednesday morning, brokers said. dan.mcgraw@icis.com