"With a stable regulatory regime and a liquid physical market comes the ability to have derivatives," said Greg Dunne, a director at carbon project developer ICECAP. Intercontinental Exchange's European Climate Exchange (ECX),
Underlying price volatility, an important prerequisite for derivatives trading, is not new to the expanding carbon market, which the International Emissions Trading Association said this week would more than double in value this year. EUA futures for Phase I (2005-07) of the EU ETS hit 32 euros a tonne before crashing in April 2006 on news of an over-allocation of credits by the European Commission. Phase II EUAs, looking comparatively stable due to stricter emissions quotas set for member states in 2008-12, still hit a 5-month high of 24.20 euros early Wednesday.
The benchmark Dec-08 contracts have fluctuated between 12 and 26 euros this year, with Swiss bank UBS last week forecasting EUA prices as high as 40 euros by 2013. Certified emissions reductions (CERs), the $5 billion carbon offsets market under the UN's Kyoto Protocol, are also seeing a derivatives market develop around them. The first exchange-traded CER options contracts were launched Friday on the Chicago Climate Exchange, though only a single contract has traded.
"Companies buy EUAs, which then just sit there not yielding anything, so a repo market is a natural development," Dunne said. A repo, normally associated with the bond market, is an agreement between two counterparties whereby one sells the other a security at a specified price with a commitment to buy it back at a later date for another specified price.
"The carbon market is starting to look like a government bond market," Richard Wilson, head of emissions at brokers Tullett Prebon, told Reuters. "Carbon offsets are similar in that there are both high quality credits and junk credits, and you'll be able track them all once the International Transaction Log is running,"
"There's an unlimited amount of things that can be done with derivatives. We're only at the beginning, we've barely even started."