April 29, 2009 / 4:35 PM / 11 years ago

Loophole aids speculation in EU carbon market

LONDON (Reuters) - A legal loophole is allowing traders to influence the price of carbon permits in Europe’s emissions trading scheme, and indirectly wholesale electricity prices too.

Market participants say that financial speculators have exploited recent volatility in European carbon permits to exaggerate price moves, and there is some evidence that individual traders are trying to move the price.

This behavior ultimately moves electricity prices: the carbon price accounts for about one fifth of household energy bills. Power plants pass on to customers the cost of permits they have to buy to balance their emissions.

“This practice exists, it’s part of the game. It should disappear with the increasing liquidity of the market,” said a trader, under condition of anonymity.

In the United States, policymakers are worried about the impact on consumer power prices of a prospective cap and trade scheme — the trading of permits which represent the right to emit a specific amount of harmful greenhouse gases.

The issue of carbon market manipulation received new focus after the administration of President Barack Obama determined to craft a cap and trade scheme in the United States, expected to get Congress approval in the next year or two.

In March, two U.S. congressmen introduced the Safe Markets Development Act, which is aimed at safeguarding a future cap and trade scheme from manipulation by setting a price ceiling.

In the European Union no single body is responsible for regulating the carbon market.

“For the time being, trade in carbon permits is not regulated,” an EU Commission official said, adding that member states’ own financial watchdogs would monitor exchange-traded carbon derivatives.

In Britain, for example, the Financial Services Authority said it would be concerned if a participant was “dominating” London-based carbon exchanges.

“I wouldn’t say it was illegal for traders to move prices. They are just playing the market for their own gains,” said Christopher Norton, partner at law firm Lovells.

The EU Commission has not responded to concerns made by an EU advisory body last year about the possible knock-on impact on power markets of market abuse in emissions trading, said a spokeswoman for the Committee of European Securities Regulators.

The European Union’s emissions trading scheme was launched in 2005 and forces factories and power plants to buy carbon emissions permits called EU allowances (EUAs) above a certain quota they get for free.


Traders can short the carbon market by selling EUAs in bulk and buying back later, making a profit as prices go down.

Whether individual participants do that is a moot point, with some traders pointing the finger at hedge funds which in turn deny such practices.

Most analysts agree that speculators move carbon prices collectively, for example by selling allowances to drive a falling market lower.

One individual can move the price up or down by 2-3 percent by buying or selling 5-10 million EUAs, worth 70-140 million euros at Wednesday’s prices, traders said.

Participants don’t have to buy permits first in order to sell them — EUA forward contracts are only cash-settled in December, making the market vulnerable to speculators.

Two European traders named one U.S. hedge fund which they said had moved carbon prices several times in the past few months on quiet trading days. But a third trader said that European market players were more to blame.

“We do not push the market one way or the other,” the U.S. hedge fund told Reuters on condition of anonymity, adding that block buys which they made of 25,000-100,000 EUAs were not enough to move prices.

In the early days of the market traded volumes were smaller and it was easier to force prices in one direction or another.

“There are a lot of operators (in the market) now and nobody for me can be big enough to counter the force of the other operators together,” said SocGen analyst Emmanuel Fages.

Reporting by Nina Chestney; Editing by Gerard Wynn and Peter Blackburn

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