CERs: Buy or sell?

Prices for certified emissions reductions have sunk by more than 60 per cent since January 2011 and are expected to fall further. So is there still a market for UN-backed carbon permits?

LONDON (Reuters) - UN-backed carbon permits were among the worst performing commodities in 2011 and trading volume fell more than 35 per cent in January this year from December as the benchmark contract became very illiquid, renewing concerns about lack of demand.

Prices for United Nations carbon credits, called certified emissions reductions (CERs), have sunk by more than 60 per cent since January last year.

In a poll by Reuters last month, carbon analysts cut price estimates for benchmark CERs in the first half of 2012 by over a quarter.

Under the UN's Clean Development Mechanism, countries and companies buy CERs to meet emissions caps agreed under the Kyoto Protocol, paying for cuts in developing country projects instead.

A certain number of CERs can be used to comply with carbon caps under the European Union Emissions Trading Scheme (EU ETS).

CER buyers are seeking ways to renegotiate purchase agreements or annul them after market prices crashed far below their wholesale credit costs, traders told Point Carbon.

Current levels are now more than €10 a tonne of carbon dioxide (CO2) below the purchase prices agreed in some contracts.

SELL

Front-year CERs hit a record low of €3.28 on January 16 as prices of the EU Allowances (EUAs) used in the EU scheme fell and the UN continued to issue massive amounts of credits.

The consistently high level of supply has muted prices, and another 12 million tonnes were issued last week.

Traded volume has also dropped. A total 107.5 million CERs and Emissions Reduction Units (ERUs) – credits issued under the Kyoto Protocol's Clean Development Mechanism and Joint Implementation schemes – were exchanged last month, down 36 per cent from December.

This compares to a rise in the volume of EUAs of 11 per cent month-on-month to 509.1 million permits.

"Compared to EUAs, the CER market is harder to trade. It has a wider bid-offer spread, which makes profit taking more difficult," said brokers at Jefferies Bache.

"With quality and quantity restrictions (...) and post-2012 uncertainty, the CER market needs buy-side to survive."

From May 1, 2013, the EU plans to ban CERs from industrial gas projects for use in its emissions trading scheme, which has affected the CER forward curve. The closer to May 1, 2013 the contract maturity is, the less attractive the contract is for CER buyers.

On Thursday the December 12 contract was around €4.30, €0.80 lower than the December 13 contract and €1.10 lower than the December 14 CER contract.

New market entrants like airlines are more interested in purchasing "green" CERs, or those that will be eligible in the ETS in the third trading phase (2013-2020), rather than "grey" CERs which will not, traders said.

"Green CERs have been gaining some ground lately, and that definitely reflects the risk associated with 'old' CERs. The green premium is likely to rise in the coming weeks, but the fact that green CERs' liquidity is close to zero is not a good sign," said Matteo Mazzoni, analyst at Nomisma Energia.

Speculators in the carbon market have declined overall but those who remain prefer the EU market, which is less risky.

Most industrial firms have already cashed in a large part of their surplus permits and they are waiting to see what the third phase will look like before they think of selling or swapping carbon permits, said Mazzoni.

"Too much uncertainty, too many credits and too many in the hands of operators with no compliance obligations. If utilities don't step up soon I believe this is going to get worse and worse," he added.

BUY

Even though the price of green and grey CERs is expected to diverge further, some traders are more optimistic about CER recovery.

"I don't see the CER market dying as fast as some other players see it," said one emissions trader.

Others expect the market for green CERs to recover even though supply is expected to increase this year which could widen the EUA-CER spread further.

"As soon as EUAs rise above €10 the spread will narrow again and CERs will be a valuable option for compliance," one carbon analyst said.

If an EU Parliament industry committee votes in favour of withdrawing a proportion of carbon permits from the market on February 28, in a bid to prop up low prices, it could help boost prices.

"This is impacting the market even now, lifting prices a little. If the vote is positive it will be bullish for EUAs meaning it is better not to sell now," another trader said.

"Even if it isn't positive, CERs still have compliance value so they shouldn't fall to zero. Grey CERs haven't got much future so the price could drop to around 3 euros. But there is been a lot of interest in green CERs over-the-counter," another trader said.

(Additional reporting by Henning Gloystein and Thomson Reuters Point Carbon; Editing by Anthony Barker)

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