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This article explores the distinction between EUA spot and futures contracts. We’ll also see why participating in the spot contracts market is the only way to contribute to fighting against global warming.
The European Union Emissions Trading Scheme (EU ETS) is the most important European policy tool in combating climate change with proven environmental impact. The more participants in this market, the greater its effectiveness in bringing decarbonization efforts.
Yet, not all EU ETS financial assets are the same - they do not have the same positive impact on the environment. This article explores the distinction between EUA spot and futures contracts. We’ll also see why participating in the spot contracts market is the only way to contribute to fighting against global warming.
A futures contract is an agreement between two parties to buy or sell an asset at a predetermined price on a specified future date. It allows investors to speculate on the future price movements of commodities, currencies, or financial instruments.
For example, a farmer can agree to sell 5 tonnes of corn to a company at $5 per bushel in six months. This agreement is a futures agreement transaction for corn, where both parties commit to the sale and purchase of corn at the agreed-upon price and date, regardless of the market price at that time.This allows the farmer to lock in the price before the actual harvest for example, and make sure they will be able to sell their corn at a given price regardless of the market conditions in the future.
However, in reality, financial companies often only enter such agreements for financial returns - before the expiry date (when they would have to actually purchase the commodity), they get rid of their futures contract by trading it in the market. So, there is no actual exchange of corn - only financial proceeds from the difference in price of the purchase and the sale of the futures contract. The financial terms to describe this is that there is no “physical delivery” but rather the future contract is settled for cash or “rolled forward” to a later date. No corn changes hands.
European Union Allowances (EUA) futures contracts are financial instruments that enable participants to buy or sell a specific quantity of carbon allowances at a predetermined price and date in the future. These contracts are traded on exchanges like the Intercontinental Exchange and usually are a mechanism for managing risk or speculating on future carbon prices. Like in the corn example, there is seldom exchange of actual allowances at maturity.
A spot contract is an agreement to instantly buy or sell an asset at its current market price. Unlike futures contracts, spot contracts involve the immediate exchange of goods or financial instruments.
For example, if you earn your salary in euros and go to the exchange office to buy dollars for your trip to New York, you are performing a spot transaction - you are buying an asset (dollars) at the current price (the exchange rate at the moment).
EUA spot contracts are agreements for the immediate purchase or sale of carbon emissions allowances at the prevailing market price. For example, as you are becoming a carbon investor and purchasing your EUAs through Homaio’s platform, you are taking part in a spot transaction - buying EUAs at the then prevailing market price. This price changes all the time as the market is very dynamic. You’ll find live EUA “spot” prices here.
As mentioned, EUA futures involve contracts with specified future delivery dates, while spot market transactions occur instantly. So, futures give the possibility to manage portfolio risk through price hedging. For example, a financial speculator may think that carbon prices will rise by the end of the year.They can sign a futures agreement to buy EUAs in December at a price that is decided today, say €60. This can be a way to protect themselves against large upward price movements - if in December the actual EUA prices are at €80, the speculator in question would benefit from this financial strategy.
Spot transactions are different and more straightforward as they only take into account the current, or “on the spot”, price of EUAs. They do not involve an obligation for the future. There can still be financial returns from spot transactions - one can buy EUAs today and later sell them at a higher price. However, there is no timeline requirement nor predetermined price levels.
EUA Futures contract prices reflect where market participants believe that EU ETS market is going. How much do participants think that one EUA will be worth in a month? In a year? In 5 years? Such dynamics determine the levels within the EU ETS futures marketplace.
On the other hand, spot markets indicate what is currently going on - what is happening with energy markets, macroeconomics, regulation… As seen in our previous article, EUA prices are driven by a multiplicity of factors.
As discussed above, participating in the futures contracts markets almost never leads to the actual exchange of carbon allowances. Instead, those financial assets serve as instruments for speculators to gain exposure to carbon allowance prices and capitalize on financial opportunities.
One can participate in the EUA spot market and become a carbon investor. By buying carbon allowances and holding them, they take out of the total volumes available to the whole European economy. As seen in our previous article, a cap and trade system involves setting a carbon budget, or a limit to the amounts of EUAs that can be issued over time. So, should more individuals take out from this common carbon budget, polluters will have less carbon allowances available
You can follow the step by step guide on how to become a participant in the EUA spot market through Homaio on this link.
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