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Current auction clears 76.9 million V15 allowances, but advance auction undersubscribed; secondary market price impact likely neutral

May 29, 2015 by Rahul Rana

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CaliforniaCarbon.info, May 29, 2015: The third California-Quebec joint auction, which was held on May 21, 2015, cleared a total of 86,743,627 of the 87,363,127 allowances offered for sale, with 619,500 V2018s failing to clear through the advance auction. The California Air Resources Board offered 42,698,426 V2015 and 8,957,500 V2018 allowances, while 1,946,676 V2013s, 11,171,647 V2015s, and 1,474,000 V2018s were offered by the Quebec regulators the MDDELCC, and 21,114,878 V2015s were provided from allowances consigned to California utilities. A total of 94 entities qualified to bid at the auction (entities listed twice were counted as one), 72 from California (representing 65.2% of the 2013 reported emissions for the state) and 22 from Quebec (representing 55.4% of the 2013 reported emissions for the province).

Transportation fuels sector participation

A total of 19 entities with emissions covered under the transportation fuels and CO2 suppliers sector qualified to bid at the auction, who altogether reported 124,726,678 MMtCO2e of emissions for 2013, which is 79.93% of the sector’s total reported emissions for that year. This is a significant increase from the last joint auction, which saw 16 qualified bidders from the sector representing only 52.3% of the sector’s reported emissions for 2013.

Top emitters

8 of the 10 top-emitting entities in the California program, based on 2013 reported emissions, qualified to bid at this auction. Tesoro Refining and Marketing Company, LLC qualified to bid at this auction for the first time since the last auction of 2013. Conspicuous absentees at this auction include Los Angeles Department of Water and Power (participated in all previous auctions) and Valero Refining Company (absent since Auction 3). Firms who do not themselves register to bid may rely on another market player’s participation at the auctions, with subsequent procurement occurring via secondary market transactions.

Current auction clearing likely to boost secondary market liquidity

The current auction offered 76,931,627 allowances (1,946,676 V2013s and 76,931,627 V2015s) that cleared at $12.29, $0.19 over the price floor, with a bid ratio of 1.16. A clearing of $12.29 can be considered modest given that the broker-quoted spot closed at $12.54 on Wednesday. Secondary market prices are thought unlikely react by any large margins following the results. A trader speaking to CaliforniaCarbon.info stated, “The current auction clearing was no surprise and it should encourage healthy trading in the secondary market.”

As some entities will now look to unload spot volume given that V2015s cannot be used to meet compliance until November 2016 at the earliest, entities may need to seek counterparties to buy up volume at the front. Sell-side pressure will likely increase given the auction cleared significantly higher than the floor and the previous auction, and the secondary market is likely to see spread and carry trades in the near future.  If prices remain level or rise, entities might find it difficult to engage counterparties to buy volumes at the front, although given the clearing price, sell-side pressure will likely keep prices from rising further in the near term. Under such a scenario, it is likely that the latter part of the forward curve will rise. Speaking with CaliforniaCarbon.info, Mark Struk, Principal at Alpha Inception, stated, “With nearly 77 million current vintage allowances soon to be distributed, we may see more demand for spread and carry trades in the secondary market, and funding rates may increase as a result”.

Advance auction undersubscribed, bearish impact expected

As the advance auction remained undersubscribed, with a bid ratio of 0.94 for the 10,431,500 V2018 allowances, it is unlikely that any positive price impact will materialize for V2018 contracts traded on the secondary market. The advance auction offers compliance entities the option of buying future vintages at comparatively cheaper rates beforehand. V2018s cannot be used to meet compliance until November 2019 at the earliest, and the V2018 Dec17, which closed yesterday at $13.49, trades considerably cheaper than the expected price floor of $14.75 in 2018, assuming a baseline inflation of rate of 1.5%. The secondary market annual cost of carry from June 2015 to December 2017 at closing yesterday was in the region of 3.5%, offering a considerable discount on the projected spot price. That the market did not clear V2018s given this situation could indicate that entities are not looking to hedge their bets so far out in the future, which will likely pull down prices for the contract.

One-day secondary market reaction

A total of 2,115,000 allowances were traded on the InterContinental Exchange yesterday, comprising 1,185,000 V2015s and 250,000 V2018s. Prices for the V2015 Jun15 dropped by a cent, while the V2015 Dec15 contract remained level, causing the implied funding rate to increase by 0.05% for the rest of 2015. Prices for V2018 contracts dropped by much larger margins following the undersubscribed advance auction, with the V2018 Dec15 contract losing $0.05 to close at $12.42.

While the financial settlement and clearing of allowances will only happen in time for June ICE deliveries, significant volumes were traded for May deliveries in the foregoing weeks (4,068,000 V2015s in the last four weeks), as entities purged spot volume in anticipation of taking on more allowances at the auction.

(This article was edited on 3 June, 2015 to re-adjust total number of qualified qualified bidders after discounting those listed twice.)

Rahul Rana: rahul@californiacarbon.info

Steven Neoh: steven.neoh@climate-connect.com

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