The first handful of trades in the U.K.’s new carbon market on Wednesday morning indicates that polluting will be more expensive for everyone from power plants to factories than it is under the European scheme.
The launch of the U.K.’s own carbon system is a replacement for the country’s participation in a nearly identical EU program that’s been going since 2005. Putting a price on carbon raises the dilemma for a British government of how to be a world leader on climate issues, but also make sure its businesses can compete globally.
U.K. carbon futures traded about 9% higher than the equivalent contract in the European Union after opening at a 12% premium. The difference will be a blow for U.K. power generators who have hedged production by buying cheaper European carbon permits as they now have to buy more expensive domestic contracts instead.
While there hasn’t been much activity yet, it’s still a good indication of how the market values U.K. permits, said Louis Redshaw, chief executive officer of Redshaw Advisors Ltd. and a former Barclays Plc trader. The auction later today could result in a higher price than in EU as utilities rush to buy credits, he said.
“There’s pent up demand,” Redshaw said. “Electric utilities will buy everything they possibly can” in the auction.
Under the EU system, carbon auctions usually begin in January, meaning British installations have gone nearly five months without any supply in the market.
The benchmark December future contract last traded at 49.50 pounds per metric ton on ICE Futures Europe, or at 57.42 euros. They changed hands at 52.55 euros in the European market, which Britain left as part of Brexit.
Scottish utility SSE Plc said in February it had suspended carbon hedging because of the risk of divergence between the systems.
The disparity may only grow as EU permits continued its bearish week. Futures fell as much as 3.2% on Wednesday. Energy Aspects Ltd., an industry consultant, warned on Tuesday that rapid price gains this year and the proliferation of very bullish option bets were signs that carbon is becoming a “speculative bubble.”
Prices have surged in recent months as the market expects the cost of emissions will rise on the back of a tougher climate agenda. Prices have surged more than 60% this year, beating most analyst estimates. Many traders are using the options market to bet that carbon will sail through 100 euros by the end of the year.
While the U.K. activity so far is only an early indication, the British government will be sensitive to any sign that businesses face a competitive disadvantage.
If the premium remains, it would allow intervention in the market. The government has given itself greater ability than the EU to meddle in the market during its first years. Three months of elevated prices would trigger intervention, compared to 6 months for Brussels. The U.K. could take a number of actions to alter the supply of permits.
The U.K. plans to auction its first 6 million permits later on Wednesday. With the low volume so far, the auction will provide crucial insight into how a wider swath of the market values the permits.
Participants in the new market will likely include everyone from utilities, factories, trading houses to hedge funds.
By Will Mathis
Originally shared by Bloomberg.