Carbon prices in Beijing and Shanghai fell sharply to record lows on thin turnover Monday amid fresh supply, regulatory uncertainty and an accumulation of surplus allowances that some observers say is likely to depress prices in China’s seven regional pilot markets this year.

Beijing Emissions Allowances (BEAs) fell 23.7% on Monday to close at 32.40 yuan ($4.92), with 4,350 allowances traded.

Shanghai Emissions Allowances (SHEAs) fell 3.2% to 9 yuan ($1.37), the lowest price ever recorded in any of China’s markets. Some 5,000 allowances changed hands on the local exchange.

The Beijing price has seen big daily moves of 6-9 yuan on several occasions in recent months, as little activity is required to shift that market due to its illiquidity.

Traders struggled to pinpoint the exact reason for the drop in BEAs, but it could be linked to a deal announced earlier in the day.

The Beijing exchange on Monday announced that brokers CMB Sinolink Investment had entered into the market’s second repo agreement, lending 10 million yuan to heating firm Huatong Group in return for an undisclosed number of BEAs, which Huatong will have to buy back at some stage.

It is unknown if Sinolink was involved in any of Monday’s selling.

Huatong did a similar deal with CITIC Securities earlier this month involving a 13.3 million yuan loan, indicating that there could be more spare supply ready to come to market, especially from cash-strapped emitters looking to raise funds as China’s economy slows.

In Shanghai, the price fell as one compliance firm that has not previously been active in the market began offering volumes, sources said.

One source said the bearish sentiment was reinforced by an institutional investor entering into a loan of 2 million SHEAs from a compliance firm.

In June last year, the Shanghai exchange announced it would allow investors to borrow up to 2 million SHEAs for speculative trading purposes. The investors have to pay a 30% margin to the exchange as a deposit, and agree a profit split with the lender.

“They have to sell now and buy back at a lower price. Usually, borrowing allowances is a bearish signal to the market,” one observer who asked to remain anonymous told Carbon Pulse.

UNCERTAINTY

Prices are bearish and volumes low across all the seven pilot markets currently.

Part of the reason is that most emitters are in the middle of verifying their 2015 emissions, with trading expected to pick up after next month’s celebrations of the Lunar New Year.

But uncertainty surrounding how the pilots will evolve into a national market, due to begin next year, is also weighing on traders, some observers said, adding that they are worried about whether allowances from the regional markets will be allowed in the national ETS.

The national government has been in talks with pilot region officials and industry lobby groups for over a year about what to do with unused allowances from the pilots when the national market opens in 2017.

The NDRC has so far shied away from addressing this crucial issue, but wherever it lands it will have a big impact on China’s carbon markets.

Ruling out the banking of these allowances to the national scheme would likely cause regional carbon prices to crash towards zero.

But allowing all or some of the of the units to be carried forward, while maintaining their value, would risk burdening the national market with a sizeable oversupply upon its launch.

“A price drop in the Shanghai market is inevitable unless the Shanghai DRC sends out a bullish signal, but of course they won’t do that because they don’t know what’s going on with the national scheme,” said another observer, who asked not to be named.

SINGLE-DIGIT MARKET?

Since the first Chinese pilot markets launched in 2013, they have been uniformly unresponsive to market fundamentals.

Prices have barely budged despite data releases on falling coal consumption, slowing GDP growth, and forced shutdowns of industrial over-capacity.

This is partly due to a lack of transparent government data available on the fundamental supply-demand balance in the markets, partly because trading is restricted to spot delivery, and partly because the regional governments overseeing the pilots have expressed a preference for roughly where prices should be trading, making it potentially risky for emitters to push prices outside that range.

Yet observers don’t expect trade to be stifled indefinitely, and analysts anticipate that prices will fall as end of the pilot period nears.

“In 2016, who is going to buy allowances anywhere in the seven pilots?” one sources asked.

“The seven pilot markets are entering an era of single digits,” added Chai Hongliang, an analyst with Thomson Reuters Point Carbon.

He predicted prices across all the pilots would be lower this year compared to last due to the accumulated over-supply, even though trading volumes are expected to remain the same.

Simon Chen, an analyst with ICIS-Tschach, said Monday’s price crash in Beijing was in line with his company’s forecasts for Q1, but offered hope for bulls in the Chinese capital’s struggling market.

“A price rebound is expected for Q2. About 600 new companies have been enrolled for compliance, so there would be more small-scale demand to push the price up,” he said.

By Stian Reklev – stian@carbon-pulse.com

Not yet signed up to CP Daily? Subscribe to our free newsletter here