Carbon market eyes easier access, hedging for ACCUs, NZUs through futures contracts

The listing of the first futures contract for carbon credits from Australia and New Zealand is expected to improve access to market for new participants, attract more capital and provide hedging opportunities for compliance entities, experts told S&P Global Commodity Insights.

The Sydney-based Australian Securities Exchange plans to list futures contract for Australian Carbon Credit Units, New Zealand Units and Large Generation Certificates on July 29, subject to regulatory approvals.

The ACCUs and NZUs are mostly traded on a spot basis in the over-the-counter market through brokers or direct deals between project developers and buyers.

"If you want to trade in the NZU and the ACCU market, most participants are restricted to the spot market," said Luke Donovan, partner, Global Carbon, at Apostle Funds Management.

ACCU spot trading requires physical delivery of the credits, which in turn requires the setting up of a registry account, a complex process of onboarding multiple counterparties, along with potential credit risks, Donovan said.

The futures listing will create greater participation for fringe parties and traders that traditionally would not be able to access these markets, a carbon trader said.

Generating liquidity

The success of the futures contracts will depend on the exchange's ability to generate liquidity by attracting significant volumes, market participants said.

"There has been strong market interest in the new products coming from our existing energy client base as well as a broad spectrum of new clients such as project developers, safeguard entities, funds and banks," said Daniel Sinclair, head of commodities at ASX.

Safeguard entities refer to facilities covered under Australia's emissions compliance program, Safeguard Mechanism, which are expected to become major drivers of ACCU demand to meet their offset obligations.

Among the potential participants, there is a high concentration of interest from banks and commodity trading houses that have usually been active in the OTC markets, Sinclair said.

ASX has also been engaging with clearing parties and market makers to help boost trading volumes.

"We are working with multiple interested parties at the moment to have market makers from day one across all three products," Sinclair said.

ASX has seven clearing participants supporting the product, majority of which are large international financial institutions.

Under the market-making activity, a participant might be required to bid and offer 20,000 mt each and remain active for at least half of the day, a second carbon trader said citing previous discussions with ASX.

In return, the exchange was likely to waive off the exchange fee of 5 Australian cents per trade for the market maker, the second trader said, adding that the design of the agreement was flexible.

ASX confirmed that its exchange fee for all participants was 5 cents/mt.

"I think liquidity will ramp up over time and it is not going to happen overnight," a third carbon trader said.

Marginal cost

Some participants, such as Safeguard entities, could choose to trade in the OTC market to avoid the cost of trading on the exchange, sources said.

A participant will likely have to pay 5 cents to a clearing partner and another 5 cents to the exchange for trading each credit, while a standard OTC broker charges just 5 cents, with no charges needed to be paid in case of a direct deal, the second trader said.

Some Safeguard entities could see ACCUs as a liability that they would want to hedge using futures, allowing them to focus on their core business, the third trader said, adding that the marginal cost will not be a major factor for them.

The decision of trading ACCU futures will depend on the level of sophistication of a Safeguard entity, the first carbon trader said.

"If you are a facility, like a coal plant, and you are using a bank or a trader to manage your derivatives risk on your coal, then you would want to ideally just add ACCUs to the list and hence just hedge it out financially and then settle on it," the first trader said.

However, if a company doesn't have a global portfolio or trading expertise, buying on the spot would be more practical, according to the first trader.

Linkage with OTC

Market sources expected the futures contract to mostly deliver the lowest-priced ACCUs, which include avoidance-based Generic and Human-Induced Regeneration ACCUs.

Platts, part of S&P Global Commodity Insights, assessed Generic ACCUs at A$33.50/mtCO2e ($22.55/mtCO2e) and HIR ACCUs at A$33.75/mtCO2e on July 5. They represent the majority of the ACCU volumes traded in the spot market, according to Commodity Insights data.

Both Generic and HIR ACCU projects have been criticized for the lack of additionality and over-crediting but the government and the Clean Energy Regulator have strongly upheld the integrity of the methods.

Higher-priced methods, such as Savanna Fire Management Indigenous and forestry-based Environmental Plantings, were assessed at A$49.95/mtCO2e and A$49/mtCO2e, respectively, Commodity Insights data showed.

"From the discussions we have held, we do expect a large proportion of buyers going to physical delivery will be compliance entities and that they may be project method agnostic, as all ACCUs are eligible for government surrender," Sinclair said.

However, if any buyer wants to surrender a particular project method, they can hedge their price risk using the futures contract while retaining the option to close their position and directly source the preferred method in the OTC market, he added.

"Some speculators who have access to both markets and want to be able to sell into the futures contracts, may buy in the spot and then sell in the futures, which will mean those markets should be closely linked," Donovan said.

The key to a successful futures contract will be the continued growth and robustness of the spot market, he said.