Nuances of the Global Cap-and-Trade Markets
Unveiling Trends, Liquidity, and the Rise of Carbon as a Strategic Asset Class
Emerging Dynamics in Carbon Trading: A Closer Look at Market Liquidity and Performance
In the ever-evolving landscape of global carbon markets, recent trends and data analyses reveal significant shifts and emerging patterns. The cC.Info Bank Coverage Index, a pivotal indicator in this domain, highlights a distinct disparity in bank coverage across different markets. Notably, the Western Climate Initiative (WCI) market boasts more bank coverage than both the Regional Greenhouse Gas Initiative (RGGI) and the European Union Emissions Trading System (EU ETS), with the UK ETS trailing as the least covered in terms of net stock.
Bank Coverage and Market Tightness
Bank coverage, a critical measure of market current tightness, indicates that a decreasing trend in coverage often signals a bullish sentiment on prices. The WCI's robust bank coverage compared to its counterparts suggests a potentially tighter market, heralding a bullish outlook for its prices.
Open Interest and Traded Liquidity
Analyzing the adjusted Open Interest (OI) provides insights into the quantity of bank stored on the forward market. This measure of relative liquidity and participant trading behavior shows that European markets, notably the EU and UK ETS, exhibit substantially more traded liquidity (EU - 0.84 & UK - 0.56) compared to the WCI (0.18) and RGGI (0.25). This disparity underscores the varying degrees of market maturity and participant activity across these platforms.
Carbon as an Attractive Asset Class
The weak long-term correlation between carbon and other financial markets has elevated carbon to an attractive asset class for diversification and, in some cases, inflation protection. This attribute was exemplified in 2023 when California Carbon Allowances (CCAs) and EU Allowances (EUAs) consistently outperformed major indices such as the S&P 500 and STOXX 600. The Sharpe ratio for EUAs and CCAs further cements their performance, outstripping financial markets, with RGGI showing fair performance in the latter half of 2023.
Market Trends in the Low Carbon Fuel Standard (LCFS)
Recent trends in the LCFS market have been indicative of the challenges and dynamics within this space. Prices fell below the $60/MT mark, a new low accompanied by a rise in credit supply. Stakeholders perceive the proposed target levels as insufficient to support the market, potentially slowing the transformation in State transport. This sentiment is echoed in the average LCFS spot credit prices, which saw a week-over-week decline of 9.68%, reaching $60.46/MT.
The RFS Market and Future Outlook
In the Renewable Fuel Standard (RFS) market, there's been a notable decline in prices across various categories since January. This trend is expected to continue in the CA LCFS, with Type 1 credit prices projected to fall in the coming weeks. Such trends highlight the need for more ambitious targets to maintain effective price signals in these markets.
Dominance and Liquidity in Trading Platforms
The trading activity for Western Climate Initiative Allowances (WCAs) showcases the competitive advantage held by established exchanges. As of January 2024, ICE dominated 96.2% of the trade activity for WCAs, a significant leap from 16.62% in June 2023. This shift in market share from Nodal Exchange to ICE underscores the liquidity and attractiveness of WCA contracts on ICE.
In other news;
A notable development in the carbon market is British power plant operator Drax's (DRX.L) plan to establish an independent business focused on large-scale, high-integrity carbon removal. This initiative, set to launch within the year and headquartered in Houston, USA, underscores the growing interest and investment in carbon capture and storage solutions as integral to achieving global carbon neutrality goals.