Credit crisis to redraw carbon markets
20 October, 2008
Carbon market participants are braced for the effects of a dramatic reduction in risk capital available to the sector, as the full impact of the credit crisis and a looming recession make themselves felt.
Concerns are growing that carbon prices could be set for substantial short-term falls, having held up well in comparison with other commodity markets. But, while the credit crisis has injected considerable uncertainty into the near-term outlook for carbon, longer-term policy questions are still causing the most anxiety.
“Cash is constrained throughout the whole of the financial system,” said Louis Redshaw, head of environmental markets at Barclays Capital in London. “There will be fewer carbon traders at the end of all this, with less risk appetite.”
The credit crisis has already claimed Lehman Brothers, and Swiss bank UBS has pulled out of the over-the-counter market for carbon, although it retains a presence in the exchange-traded market.
Meanwhile, RBS – which absorbed ABN Amro’s carbon trading team – is under pressure to scale-back its investment banking operations, following its bail-out by the UK government.
And questions remain over the fate of the carbon desk at Belgian-Dutch bank Fortis – one of the largest carbon teams in the market. Its Belgian business – within which the team, and its book of business, sits – has been bought by France’s BNP Paribas, which also trades emissions. However, it is understood that the head of the Fortis carbon trading team is working to transfer the desk to the bank’s Netherlands operations. That part of the bank is in the hands of the Dutch government.
There is also concern that hedge funds could step back from the market. Most lock in their investors for three months, so the effects of expected investor redemptions from the sector may be yet to make themselves felt. “I expect that a lot of hedge funds will walk away, and some banks are already pulling back in terms of proprietary trading desks,” said one market participant.
Utilities have cut their credit exposure to a number of banks, according to traders, and more business is being directed to the exchanges, which effectively removes counterparty credit risk.
However, trading volumes and prices have held up throughout the crisis. While oil – which often influences energy, and thus carbon, prices – fell by around a third between 11 September and 16 October, prices of December 2008 EU allowances (EUAs) were down just 5%, to €21.91 ($29.20) from €23.07.
Some think, however, that prices could be set to tumble, as recession takes hold. On 15 October, Deutsche Bank revised downwards its price forecast for 2008 EUAs to €30/t from €40/t, citing expected lower emissions over 2008-10.
But Katrin Fuhrman, carbon analyst at Fortis Bank, remains neutral for 2008, and bullish on prices for the rest of the period. She predicts an EUA shortfall of 1,000 million tonnes in the EU ETS out to 2012, leaving plenty of headroom before the system becomes oversupplied with allowances. The ability to carry EUAs over to the next phase will insulate the scheme from the price crash that hit in 2006, when it became apparent that the first phase of the scheme was oversupplied, she added.
Meanwhile, the effect of the credit crisis on the supply of certified emission reductions is particularly unclear. With an overall reduced appetite for risk, less capital from Western investors is likely to be available for projects in emerging markets but, argued Geoff Sinclair, head of carbon sales and trading at Standard Bank in London, much Clean Development Mechanism financing is provided by local financial institutions.
However, Jack Cogen, president of New York-based environmental asset management company Natsource, warned that some CDM projects could under-deliver, as an economic slowdown takes hold in emerging markets: “In industrial gases, will there be a supply issue? It’s the same with steel plants – which plants will be dispatched first? Is the primary line running?”
On the other hand, there are also concerns that distressed sellers – desperate for cash – may be forced to come to market, driving down prices in the near-term.
But, while the credit crisis is clouding the short- and medium-term outlook for carbon markets, policy developments in the US and internationally remain the most pressing issues for many participants.
“If a recession significantly reduces demand for carbon, and if the politicians decide to aggressively soften their post-Kyoto stance, the system could potentially be long [allowances],” said a carbon trader at a major European utility. “That would be really detrimental for us as we’re planning our new build.”
“Will this change US policy?” Cogen asked. “At this point, there’s no public statement that things are anything but on track. But will an economic slowdown lead to a timing change?”
He added that trading and markets are out of favour in Congress, and that it will be imperative for industrial emitters to make the case for emissions trading, to provide them with flexibility to meet emissions targets.
