Futures Market Efficiency in the EU ETS Dr Paul Twomey Centre for - PowerPoint PPT Presentation

Futures Market Efficiency in the EU ETS Dr Paul Twomey Centre for Energy and Environmental Markets (CEEM), UNSW based on work by Oliver Sartor Centre for Energy and Environmental Markets (CEEM), UNSW

Outline � Motivation � Carbon Futures Market Development � Methodology � Summary of Results � Conclusions & Possible Future Improvements The potential for sustainable energy futures 2

Why care about carbon futures market efficiency? � Futures prices used for: – Cost effective risk sharing and transfer (hedging) – Informed investment decision making High carbon price risk in the EU ETS market may be a significant factor in delaying low carbon investments (Neuhoff, 2007). � Considerable evidence that the forecast error (MSE) of futures prices are lower than alternative price predictors in commodity and other markets. � Relevance for when to auction or issue permits The potential for sustainable energy futures 3

Market Development – Phase I 2005-2007 EU ETS Price History (Phase 1) 35 30 Price (Euros) 25 20 15 10 5 0 2/11/2005 4/04/2005 5/20/2005 7/07/2005 8/23/2005 10/07/2005 11/23/2005 1/10/2006 2/24/2006 4/12/2006 5/30/2006 7/14/2006 8/30/2006 10/16/2006 11/30/2006 1/18/2007 3/06/2007 4/23/2007 6/07/2007 7/24/2007 9/07/2007 10/24/2007 12/10/2007 Time (2005 - 2007) ECX Dec-06 Futures ECX Dec-05 Futures ECX Dec-07 Futures ECX Dec-08 Futures Bluenext Spot Nord Pool Dec-08 CER The potential for sustainable energy futures 4

Market Development - Phase II 2008 EU ETS Price History (Phase 2) 40 35 30 uros) 25 rice (E 20 15 P 10 5 0 8 8 8 8 8 8 8 8 8 8 8 8 8 8 8 8 8 8 8 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 / / / / / / / / / / / / / / / / / / / 3 7 1 4 8 3 1 4 8 3 7 0 4 8 2 5 9 2 6 0 1 3 1 2 1 3 1 2 1 2 1 2 0 2 0 1 0 1 / / / / / / / / / / / / / / / / / / / 2 3 3 4 4 5 5 6 6 7 7 8 8 9 9 1 1 1 2 Time (1/3/ - 22/9/2008) ECX Dec-08 Futures ECX Dec-09 Futures ECX Dec-10 Futures ECX Dec-11 Futures ECX Dec-12 Futures ECX Dec-13 Futures Bluenext Spot Nord Pool Dec-08 CER The potential for sustainable energy futures 5

Market Development Phases I & II The potential for sustainable energy futures 6

Market Development – Contract Volumes Volumes per Contract Type per Year (Non-LEBA) 1400000 1200000 1000000 2008 Kt CO2e 800000 2007 600000 2006 400000 2005 200000 0 8 9 0 1 2 5 6 7 8 9 0 1 2 3 s t o R 0 0 1 1 1 0 0 0 0 0 1 1 1 1 p - - - - - - - - - - - - - - E c c c c c c c c c R R R R R S e e e e e e e e e C E E E E E d d d d d d d d d C C C C C t o p S Permit Type/Maturity The potential for sustainable energy futures 7

Modelling Approach � Two approaches: – Test cost of carry model − δ − = ( r )( T t ) F S e T , t t – Granger causality tests to see whether futures lead price discovery ⎡ ∧ ⎤ = { } { } + ε * Y W , Z Y ⎢ + ⎥ t 1 + + t t t 1 t 1 ⎣ ⎦ n n � Looks at just Phase II 2008 trading from March to September. The potential for sustainable energy futures 8

There is convergence towards the Cost of Carry predictions Cost of Carry Prediction vs Reality (Dec 2010 Futures) 35 30 Price (Euros) 25 20 0 50 100 150 Trading Day Index 2008 ECX Dec2010 Bluenext Spot Nord Pool Dec2010 LEBA Dec2010 Cost of Carry Futures Price Prediction for Dec 2010 The potential for sustainable energy futures 9

The Granger Causality Tests also mostly confirm that future prices lead spot prices TABLE 13: TESTS FOR GRANGER CAUSALITY FROM EUA FUTURES TO SPOT PRICES REGRESSAND FULL SAMPLE (N=846) PARTIAL SAMPLE (N=355) Log Spot Price t WALD WALD STATISTIC P-VALUE STATISTIC P-VALUE REGRESSORS 1.9000 0.0564 1.4100 0.1889 Log Dec-08 Futures 1.0300 0.4141 0.8800 0.5314 Log Dec-09 Futures 3.2700 0.0011 4.6000 0.0000 Log Dec-10 Futures 1.4800 0.1607 1.6900 0.0989 Log Dec-11 Futures 0.8200 0.5850 0.9400 0.4808 Log Dec-12 Futures #Lags per Variable 8 8 Degrees of Freedom 8 8 Parameters 846 355 Observations The potential for sustainable energy futures 10

Conclusions & Possible Improvements � The cost of carry model has clearly begun to describe carbon futures prices in Phase 2. – Contrasting with Milunovich & Joyeux (2006)’s findings on Phase 1 – Aiming to replicate analysis with OTC data for Phase I � Combined evidence supports the assertion that EU carbon futures markets are beginning to perform a price signalling function. � Clear effect of short Phase length in the trading volume data (as noted by other authors, e.g. Buchner (2007), IEA (2007)) � A longer time frame and more frequent data on energy prices would definitely improve the analysis. The potential for sustainable energy futures 11