Bullish allowance price expected upon initial South Korean ETS trading

08 January 2015

With a coverage of 526 entities within 23 different industries, the South Korean ETS (Emissions Trading Scheme) has been officially introduced on 1 January 2015, and scheduled to kick-start its initial trading on 12 January 2015.Trading place will be the Korean Exchange (KRX), and only compliance companies will be allowed to trade KAUs (Korean Allowance Units).

ICIS’s analysis suggests that the price will see a rather sharp rise in the first trading days. The opening price is expected to be set rather low within the range of  $6-9 per KAU, but the price is expected to rise sharply.

The main demand for carbon allowances is attributable to the power and energy industry, which is expected to be significantly short. Power and heat production account for the largest share of emissions in the South Korean ETS and the allocation of volumes to that industry is significantly below the expected emissions in the following years. Within the first compliance period of the South Korean ETS (2015-2017), the power and energy industry is expected to be short by nearly 90m tonnes CO2-eq, according to ICIS’s carbon emission forecast.

The strong demand coming from the power industry, however, doesn’t seem to be able to find enough supply priced at below $10 in the market. Even if the rest of the industries reduce their emissions as to the government target ratio, approximately 50m KAUs of shortage is expected before the use of offset credits and supply of reserves.

Additionally, low trading volumes are expected in the first trading months. Uncertainties in the market, especially regarding the compensation of emissions costs for power producers in the wholesale power market, will decrease market activity from the power and energy industry. The main influence on the prices in the first weeks of trading will be not be the fundamental balance of the market but the behaviour of market participants. Uncertainties in the market support the preference of a long position over a short position. ICIS’s analysis suggests that demand will exceed supply and prices will rise in the short term, even with low trading volumes.

In the meantime, prices above $30 seem unlikely until 2017. For the first compliance period, the government could intervene the market with market stabilisation measures once the three-month average price rises above KRW10,000, or approximately $10. Given that the trigger price of $10 was introduced in order to lower the compliance costs, thereby possibly limiting the maximum penalty below $30, companies are not expected to be incentivised to buy allowances at $30 or higher.

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