Friday, October 9, 2009

Barclays on Carbon (Super-contango)

From FT Alphaville:

Carbon indicators

There are three important industrial scenarios for Europe’s carbon allowance market - or EUA - investors across the spectrum should be aware of:

1) A rising industrial output scenario – good for the economy; not so much industrial players short of carbon credit. Nonetheless, the ideal framework for the programme.

2) A sharply falling industrial output scenario — better for industrial players; not necessarily the carbon market itself if it leads to an allowance oversupply that threatens to crash the market altogether. Worst case scenario for the carbon market.

3) A moderately falling industrial output scenario — great for cash-strapped industrial players who can monetise extra allowance length via the carbon futures market, especially so if expectations of a recovery further down the line are firmly in place. Moderately in the context of carbon credits is still a lot though.
It’s scenario three, by the way, that we’ve mostly been witnessing since the crisis took hold — something that led to a bit of a super-contango appearing in the term structure of the carbon futures market.
But as ever with a synthetic market like the carbon market, matters unexpected can get in the way to flip things the wrong way. A European Court of First Instance judgement on Poland’s and Estonian’s National Allocation Plans, for example, now threatens to pump extra length into the market just when it might be most vulnerable.

That’s because, as Barclays Capital’s commodities team explained in a recent report, the market is already looking pretty long:

…out to 2012, the market is long EUAs by some 225 Mt — an increase in length from our previous report (-195 Mt) — a 15% increase in the gap to cap estimate (although only a 1% decrease in estimated emissions).

2013 is a net short of 170 Mt; and although emissions begin to increase in 2010 due to moderate economic growth, the still-poor performance of industrial output should keep those emissions increases in check.