Why the price of a tonne of CO2 suddenly goes down on the European market

Posted on Dec 19, 2019 2021 at 16:11Updated Dec 19. 2021 at 16:12

After having chained the records for weeks, the price of the ton of CO2 ended up stalling. Down by more than 13% on Friday, the price of “rights to pollute” that European manufacturers must buy to offset their CO2 emissions fell below 74 euros. This fall, the largest since March 2020, comes barely two weeks after a new historic record of more than 90 euros.

The increase in recent months, driven by European climate commitments and soaring gas prices, is making some European countries cringe. When the price of gas goes up, electricity producers burn more coal, which is cheaper but more polluting. They then have to buy more carbon allowances and the price of CO2 soars.

High volatility

During the European summit which ended on Thursday, the carbon market was particularly criticized. The Polish Prime Minister believes that it is not working. Along with other countries including the Czech Republic and Hungary, Warsaw blames financial speculation for the rise in prices and would like to ban it.

Spain and France were concerned about the levels of volatility. Paris called for further analysis made last month by Esma, the European market policeman. Which had felt that there was no excessive speculation in the market. Conclusions disputed by a study by the Postdam Institute, published on Wednesday, which calls on the Commission to strengthen supervision of the carbon market in order to avoid distortions caused by financial speculators.

Rising speculation

It must be said that upside speculation played an important role as the end of the year approached. Indeed, many call options with exercise prices above 80 euros expired on Wednesday.

On the financial markets, when you buy a call option, you acquire the right to buy a security (here a carbon allowance) at a later date (exercise) at a predetermined price. The seller of the option is obligated to sell the security at the predetermined price on the exercise date if the owner of the option decides to exercise it.

When the market price is higher than the option price, the buyer has an interest in exercising the option in order to be able to pocket the difference. However, with the acceleration of prices at the end of the year, many call option sellers had to buy the underlying allowances on which they had sold options, in order to be able to supply them when the options were exercised.

“A more marked profit taking”

Conversely, the futures contracts for December 2021 expire on Monday. Those who hold them for purely speculative purposes could therefore receive physical carbon quotas linked to these contracts. However, they risk selling these allowances with delivery in December 2021 and buying futures contracts due in December 2022, weighing on prices.

“The market is repositioning itself, as one might expect,” said Marcus Ferdinand, carbon specialist at THEMA firm. “After a year when prices have exploded, the profit taking is more marked,” he explains. He points out, however, that the 2021 price hike remains mostly driven by fundamentals.

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