Bulk demand from big emitters in China’s pilot carbon market has opened up an over-the-counter (OTC) market trading at a slight discount to the exchanges, creating cheaper compliance options for emitters and arbitrage opportunities for speculators as annual compliance deadlines approach.
Rules in the pilot markets stipulate that allowance trades must be done on the local carbon exchanges.
But if deals are of a certain size, normally bigger than 10,000 or 100,000 permits, traders can negotiate deals bilaterally or via a broker. The deals will be cleared on the local exchange, but the price does not get published.
“Some compliance companies are looking for large volumes of allowances from the OTC market. For more than 10,000 allowances they rely on the brokered market,” one trader told Carbon Pulse.
Bulk trades provide sellers – normally companies that have been over-allocated and aren’t particularly price sensitive – with an easy option to offload their surplus units.
They are therefore happy to sell allowances at around 1 yuan ($0.16) below exchange prices, sometimes more, according to traders.
ARBITRAGE
OTC volumes are a relatively small, but growing part of the Chinese markets.
By the end of April, nearly 1.9 million permits had traded OTC in Beijing, 1.6 million in Hubei, 820,000 in Tianjin and 690,000 in Shanghai.
The emergence of an OTC market has been welcomed with open arms by major emitters, which pay less for their allowances and also get away with doing fewer trades – a boon for compliance managers in bureaucracy-heavy state-owned enterprises.
But it has also created arbitrage opportunities for speculative traders, especially in the investor-friendly Hubei ETS, where more allowances trade than in all six other markets combined.
Some speculative traders have been seen buying parcels of 10,000 allowances or more OTC and then selling them back in smaller clips on the exchange at higher prices.
Speculators also provide a sizeable share of supply in Hubei. Last March, before the market opened, the government auctioned 2 million allowances to market participants, most of which were picked up by speculators at 20 yuan each.
The price in recent months has hovered in the 24-27 yuan range, offering traders the opportunity to close their positions with a profit, even if they sell below exchange prices.
“The main strategy for speculation is to go long, as long as allowances are cheap. OTC deals have been for both compliance and speculation, but I think in coming weeks it will mainly be compliance buyers,” one trader said.
Hubei firms need to surrender allowances to the government to cover for their 2014 emissions by May 31. The other markets have compliance deadlines in June and July.
By Stian Reklev – stian@carbon-pulse.com
