Abstract
This chapter examines the EU Emissions Trading Scheme options and futures markets dynamics during the period 2005–2011. Observations on returns, volatilities and volumes on derivative instruments are studied. In addition, spot/future correlations, term structures and option implied volatility smiles and surfaces are examined. The aim is to ascertain whether the behavior of the EU ETS derivatives markets can be compared to that of commodity markets, specifically the developed West Texas Intermediate (WTI) crude oil derivatives market. The results indicate that the EU Emissions Trading Scheme derivatives markets have matured markedly since the start of Phase 2 of the Scheme, with rising volumes and declining return volatilities. Spot/future correlations, term structures and option volatility smiles and surfaces exhibit comparable behavior over time, albeit with certain discrepancies, with that found in the developed WTI crude oil derivatives market. These results are valuable both for traders of EU allowances and for those policy makers seeking to improve the design of the EU Emissions Trading Scheme.
This is a preview of subscription content, log in via an institution to check access.
Access this chapter
Tax calculation will be finalised at checkout
Purchases are for personal use only
Notes
- 1.
It is noteworthy that, according to Europol, the European law-enforcement agency, the marked development in these statistics, for the EU ETS derivatives markets, occurred despite a backdrop of Europe having lost about 7.4 billion euros in taxation revenue for the 18 months prior to December 2009 because of CO2 VAT trading fraud.
- 2.
The balance consisted of spot along with UN-backed credits.
- 3.
It is important to note that in Phase 1 only inter-period banking of allowances was prohibited, there were no restrictions on intra-period banking.
- 4.
Borak et al. (2006) also find evidence of a weakly increasing term structure when examining Phase 2 instruments.
- 5.
Bredin, Hyde and Muckley (Bredin et al. 2009) examine the microstructure behaviour of trading volume, return volatility and transaction duration (time between consecutive trades) for Phase 1 and the initial contract of Phase 2 using transaction level data.
- 6.
The summary statistics for WTI December futures returns are reported in the Appendix to this chapter, see Table 5.8.
- 7.
See Bredin, Hyde and Muckley (Bredin et al. 2009) for an intra-day volatility and volume analysis of Phase 1 and early Phase 2 EUA December expiry futures contracts.
- 8.
Borak et al. (2006) used prices to conduct their correlation analysis.
- 9.
Borak et al. (2006) also find that futures prices within the same Phase exhibited stronger correlations.
- 10.
The sample of data used here is considerably larger than that adopted by Borak et al. (2006).
- 11.
Qualitatively similar term structures are present in 2009. These are available from the authors on request.
- 12.
The thin range of strikes has the implication of displaying the sharp trough on the smile.
- 13.
Building volatility surfaces involves a large amount of interpolation and the surfaces would primarily consist of prices and implied volatilities that are not available in the market.
- 14.
- 15.
One interesting fact to note is how the number of strikes actively traded increases as the maturity of the options increases.
References
Alberola, E., Chevallier, J., & Cheze, B. (2009). Emissions compliances and carbon prices under the EU ETS: A country specific analysis of industrial sectors. Journal of Policy Modelling, 31, 446–462.
Benz, E., & Hengelbrock, J. (2008). Liquidity and price discovery in the European CO 2 futures market: An intraday analysis (Working Paper). Bonn: Bonn Graduate School of Business.
Benz, E., & Truck, S. (2009). Modelling the price dynamics of CO2 emissions allowances. Energy Economics, 1, 4–15.
Bloch, D. (2010). A note on emissions trading: The pricing of carbon derivatives (Working Paper). Paris: Université Paris VI Pierre et Marie Curie.
Bohringer, C., Koschel, H., & Moslener, U. (2008). Efficiency losses from overlapping regulation of EU carbon emissions. Journal of Regulatory Economics, 33, 299–317.
Borak, S., Hardle, W., Truck, S., & Weron, R. (2006). Convenience yields for CO 2 emissions allowance futures contracts (Working Paper). Berlin: Humboldt-University of Berlin.
Bredin, D., Hyde, S., & Muckley, C. (2009). A microstructure analysis of the carbon finance market. Paper presented at the Finsia/Melbourne Centre for Financial Studies Banking and Finance Conference, Melbourne, Australia. Retrieved from http://www.melbournecentre.com.au/Finsia_MCFS/2009/Papers for website/25_Hyde_Carbon_Futures_Trading.pdf.
Bredin, D., & Muckley, C. (2011a). An emerging equilibrium in the EU Emissions Trading Scheme. Energy Economics, 33, 353–362.
Bredin, D., & Muckley, C. (2011b). The price forming process in energy markets. In A. Dorsman, W. Westerman, M. B. Karan, & Ö. Arslan (Eds.), Financial Aspects in Energy: The European Perspective (pp. 88–107). Berlin: Springer-Verlag.
Bunn, D. W., & Fezzi, C. (2007). Interaction of European carbon trading and energy prices, (Working Paper 63). Milan: Fondazione Eni Enrico Mattei.
Chestney, N. (2011). EU CO 2 market strong in 2010, volume up 7 pct—report, Reuters, [Online 13/01/2011]. Retrieved from http://in.reuters.com/article/2011/01/13/idINIndia-54143320110113.
Chevallier, J., & Sevi, B. (2009). On the realized volatility of the ECX CO 2 emissions 2008 futures contract: Distribution, dynamics and forecasting (Working Paper). Paris: Université Paris X Nanterre.
Chevallier, J., Sevi, B., & Le Pen, Y. (2009). Options introduction and volatility in the EU ETS (Working Paper). GRANEM.
Christiansen, A., Arvanitakis, A., Tangen, K., & Hasselknippe, H. (2005). Price determinants in the EU emissions trading scheme. Climate Policy, 5, 15–30.
Considine, T. J., & Larson, D. F. (2001a). Uncertainty and the convenience yield in crude oil price backwardations. Energy Economics, 23, 533–548.
Considine, T. J., & Larson, D. F. (2001b). Risk premium on inventory assets: The case of crude oil and natural gas. Journal of Futures Markets, 21, 109–126.
Daskalakis, G., Markellos, R. N. (2008). Are the European carbon markets efficient? Review of Futures Markets, 17(2), 103–128.
Daskalakis, G., Psychoyios, D., & Markellos, R. N. (2009). Modelling CO2 emission allowance prices and derivatives: Evidence from the European trading scheme, Journal of Banking and Finance, 33, 1230–1241.
Delarue, E. D., Ellerman, A. D., & D’haeseleer, H. (2008). Short-term CO 2 abatement in the European power sector (Working Paper No. 08.008). Cambridge, MA: CEEPR, MIT.
Ellerman, A. D., & Feilhauer, S. (2008). A top-down and bottom-up look at the emissions abatement in Germany in response to the EU ETS (Working Paper No. 08-017), Cambridge, MA: CEEPR, MIT.
Escobar, M., Hernandes, N., & Seco, L. (2003). Term structure of commodities futures, forecasting and pricing. Toronto, Canada: RiskLab, University of Toronto. Retrieved from http://www.risklab.ca/seco/Commodities term structures.pdf.
Fusaro, P. C. (2007, September). Energy and environmental hedge funds, Commodities Now, 11(3), 61–63. Retrieved from http://www.commodities-now.com/publications/commodities-now/publication/7.html.
Kanen, J. L. M. (2006). Carbon trading and pricing, London. UK: Environmental Finance. Publications.
Kara, M., Syri, S., Lehtila, A., Helynen, S., Kekkonen, V., Ruska, M., et al. (2008). The impacts of EU CO2 emission trading on electricity markets and electricity consumers in Finland. Energy Economics, 30(2), 193–211.
Lowrey, C. (2006). A changing environment. FOW Energy, Spring, 24–26.
Mansanet-Bataller, M., & Pardo, A. (2008). What you should know about carbon markets. Energies, 1, 120–153.
Mansanet-Bataller, M., Pardo, A., & Valor, E. (2007). CO2 prices, energy and weather. The Energy Journal, 28, 73–92.
Mills, P., (2008). The greening of markets. Finance and Development, 45(1). Washington, DC: IMF.
Milonas, N., & Henker, T. (2001). Price spread and convenience yield behavior in the international oil market. Applied Financial Economics, 11, 23–36.
Newbury, D. (2009). The role of carbon markets in preventing dangerous climate change. House of Commons: Environmental Audit Committee Publications.
Paolella, M. S., & Taschini, L. (2008). An econometric analysis of emission trading allowances. Journal of Banking & Finance, 32, 2022–2032.
Pindyck, R. (2001). The dynamics of commodity spot and futures market: A primer. The Energy Journal, 22, 1–29.
Rittler, D. (2011). Price discovery and volatility spillovers in the European Union Emissions Trading Scheme: A high-frequency analysis. Journal of Banking & Finance, 36, 774–785.
Samuelson, P. (1965). Proof that properly anticipated prices fluctuate randomly. Industrial Management Review, 6, 41–49.
Seifert, J., Uhrig-Homburg, M., & Wagner, M. (2008). Dynamic behavior of CO2 spot prices. Journal of Environmental Economics and Management, 56, 180–194.
Uhrig-Homburg, M., & Wagner, M. (2009). Futures price dynamics of CO2 emission allowances: An empirical analysis of the trial period. Journal of Derivatives, 17, 73–88.
Author information
Authors and Affiliations
Editor information
Editors and Affiliations
Rights and permissions
Copyright information
© 2013 Springer-Verlag Berlin Heidelberg
About this chapter
Cite this chapter
Bredin, D., Ó Ciagáin, É., Muckley, C.B. (2013). Energy Derivatives Market Dynamics. In: Dorsman, A., Simpson, J., Westerman, W. (eds) Energy Economics and Financial Markets. Springer, Berlin, Heidelberg. https://doi.org/10.1007/978-3-642-30601-3_8
Download citation
DOI: https://doi.org/10.1007/978-3-642-30601-3_8
Published:
Publisher Name: Springer, Berlin, Heidelberg
Print ISBN: 978-3-642-30600-6
Online ISBN: 978-3-642-30601-3
eBook Packages: Business and EconomicsEconomics and Finance (R0)