February 24, 2014 by CaliforniaCarbon.info
CaliforniaCarbon.info, February 24, 2014: Concerns about long-term oversupply in the California cap-and-trade market will likely persist after the results of last week’s auction failed to provide a badly-needed confidence boost. With bid ratios dropping dramatically for both the current vintage (V2014 – 1.27) and the forward vintage (V2017 – 1.11), it seems participants took a conservative approach to their bid strategies.
Some 28.8 million allowances went on offer last week. The current vintage – a combination of state-owned and utility-consigned instruments – constituted just over 19.5 million, while the forward vintage – a quarter of a tenth of the emissions budget for the year 2017 – provided 9.26 million. All allowances offered were sold, but only just.
Falling bid ratios
The ratio of the total volume of bids to the available supply is often an illuminating statistic. In this case, the decline of just over 0.5 in this value for both vintages, when comparing this auction against the last, reflects a clear reduction in the visible demand at auction. In contrast, the current vintage saw 247% subscription at the first auction of 2013.
Hugging the floor
This auction has brought the current vintage clearing price the closest it has ever come to the price floor since the inaugural edition back in 2012. In spite of the floor price increase from $10.71 to $11.34 as we moved into 2014, the V2014s cleared at $11.48, the same price at which the V2013s had sold back in November. The gap between the price floor and the clearing price is only 14 cents this time; it had been 77 cents in November, and $3.29 in May last year, when the auctions cleared at their highest ever price of $14.00. The forward vintage cleared at a mere 4 cents off the floor at $11.38.
Given that the secondary market for V2014 California carbon allowances (CCAs) delivering in March 2014 was trading on the day of the auction at $12.01, a clearing price in the vicinity of $11.48 was not unexpected. Previous auctions have shown – a freak result in August 2013 aside, when a $1.28 gap materialised between the primary and secondary prices on auction day – that a price spread in the region of $0.40 to $0.60 is a regular occurrence. In many ways, it is the drop-off in subscription rates that will more greatly concern the market.
A long market?
It remains to be seen if the reduced demand at this auction has more to do with participants adopting a wait-and-see approach within the 2014 cycle, or if the market has fundamentally ‘lengthened’ in the preceding months. Last year, although the bid ratio fell from 2.47 to 1.78 between the February and May auctions, the clearing price actually rose from $13.92 to $14.00. In general, 2013 observed an early peak to allowance demand, with prices falling away toward the end of the year and clearing at $12.22 and $11.48 respectively in the August and November auctions for current vintage CCAs. Some will hold out hope that we are merely seeing a strategic difference play out, with compliance buyers prepared to wait till later in the year to make their move.
Nevertheless, political events in recent weeks have done little to help market confidence. Two weeks ago, the Air Resources Board (ARB) released a Scoping Plan update which proposed to set midterm targets for emission reductions only in 2017, which many stakeholders have deemed too late. An earlier target would help the market take positions with confidence at an earlier date. One day after the auction, Senator pro tempore Darrell Steinberg proposed a bill – unlikely though it is to succeed – to take the fuels sector out from cap and trade and subject it instead to a carbon tax. It is uncertain if the rumours surrounding that announcement – and a suspected leaked internal memorandum detailing the plans which Steinberg eventually announced – played any part in influencing bidding behaviour.
This will be seen as a minor blow to the market, which had earlier seen some encouraging demand patterns in January when drought reports led to increased buying, conceivably by energy-sector entities anticipating greater compliance needs. Prices for the V2014 benchmark (Dec 2014 delivery) had climbed from $11.95 on Jan 10 to $12.55 within two weeks, although they just as quickly returned to settle in the $12.00-$12.20 range since.
Price direction for the secondary market
Auctions play an important role in price discovery. A large differential between the primary and secondary trading prices can often lead to significant readjustment on the secondary market. Last August, when the auctions cleared at $12.22, $1.28 below the same day’s ICE price for the benchmark V2013, the secondary market responded by losing 90 cents in a day, falling from $13.35 on the day of announcement to $12.45 the next day. Last November, when the primary market cleared $0.60 below the corresponding ICE price, the secondary market showed no major price shift, continuing to trade in a narrow 16-cent range in the ensuing two-week period.
Given the $0.53 differential at this auction, it appears unlikely that the secondary market will see any significant price shift in the coming days as a result of the auction. This spread affirms that the market was fundamentally efficient heading into the auction.
The sale of allowances at this auction generated $329.7 million in revenue. This is the highest total the program has seen at a single auction – the previous record was $296.9 million, set in November 2013. Of this, only 39.6% – or $130.7 million – will go to the state, with the rest being given to utilities in return for the allowances they consigned. Utilities will use this value to protect consumers from the potential rising costs associated with cap and trade.
Auction participants will now decide whether or not to take part in the Auction Reserve Sale, which takes place on the 3rd April this year. The reserve sale notice will be put up on 4th March, and the application period for participation closes on the 17th March, with bid guarantees due a week thereafter. No entity has ever participated in an auction reserve sale since the inception of the cap-and-trade program, because prices have remained well below $40, the price at which the cheapest reserve allowances are sold.
Given today’s results, it can be said with much confidence that we will see no interest in the reserve sale.
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