Introducing carbon futures in Asian markets is expected to be challenging due to the regulators' fragmented policies, hesitation to tighten emission control measures, and a lack of coordination, experts said Jan. 25 at the APAC Commodity Trading Week.
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Register NowPresent-day voluntary carbon markets are under a trust crisis, while most Asia-Pacific compliance markets face low liquidity. Some market participants are of the opinion that carbon futures can provide a concrete, forward-looking price that allows them to think beyond short-term, bearish sentiment, and evaluate longer-term returns and raise capital to get their projects off the ground.
There have been some futures products established, like allowance futures in the EU's and California's regional compliance markets, and Global Emission Offset (GEO) contracts in the voluntary market. These products have helped manage price volatility. However, futures products and trades are relatively limited in the Asia-Pacific.
"We're still at very much an embryonic stage when it comes to futures and prices," Tobias Davis, Head of Carbon Origination at ENGIE, said at the conference.
He explained that futures markets create a clean mechanism to manage price volatility, which is essential especially considering the carbon market's fluctuations over the past 12-24 months. "But the challenge we have today is that we have a futures market that is still uncertain. It doesn't carry the required element of liquidity to really effectively manage price risk."
Compliance market challenges
"When it comes to compliance markets, it is the level of demand that justifies whether the futures market should exist," said Vidur Nayar, Head of APAC Environmental Trading at Hartree Partners, adding that the governments of South Korea and Japan need to tighten their allowance supplies and accelerate market evolution.
Nayar said South Korea owns one of the largest and most mature compliance markets. "But for a long time, participation has been restricted to emitters only. Recently, they've allowed 21 financial intermediaries, but the market is still heavily oversupplied."
He added that there's a banking limit in the South Korean market which forbids keeping many unused allowances for future trading. Due to the banking limit and no signal of tightening supplies over time, market participants prefer selling their allowances in the spot market to get quick cash.
"If you look at Japan again, they're doing this in a different way. But everyone is being very careful from a regulatory perspective because they don't want to negatively impact the export industries," he pointed out.
Different from a conventional compliance market, Japan allows companies, instead of the government, to set emissions reduction targets, resulting in low demand in the country's carbon market.
ENGIE's Davis said nurturing a regional futures market, like the one in the EU, requires seamless governmental coordination, while for regions like Southeast Asia, which is "incredibly fragmented," such level of coordination may be impossible.
"In an ideal world, they [Southeast Asian governments] will sit down and come up with an associated body," Davis said, adding that "it's a very, very difficult thing to achieve."
Nevertheless, Hartree's Nayar highlighted that recent policy evolution in Australia creates some opportunities for carbon futures. As the government introduced more stringent targets for their compliance entities, a meaningful demand pool has been established.
"I would say we're witnessing the start of a futures market in Australia, which excites me, but again, very much subject to policy and ensuring that demand is strong enough and comes through," he said.
Voluntary market issues
Voluntary carbon markets also face difficulties in scaling up futures demand, market participants said.
"You had a situation where one press release or news story criticizing certain projects led to questions of what is the right portfolio," Hartree's Nayar said.
On the exchanges, they have to really prioritize liquidity and volume to enable the exchange and the validity of the futures contracts, Nayar also said, adding that "unfortunately, with all these disparities in what is acceptable, it's very hard to create a standardized contract."
"For futures, one uncertainty is whether pre-agreed supplies can be delivered. The media criticized nature-based projects, then the standards adjusted their methodologies to issue fewer carbon credits. Now the media starts questioning cookstove projects, will we also face shrinking supplies?," a carbon trader told S&P Global Commodity Insights on the sideline of the conference.
"Another concern is price. As a buyer, I want a futures contract to hedge significant price increases in the future, right? But now buyers worry that VCM [voluntary carbon market] prices will instead remain low," the trader added.
Platts, part of S&P Global, assessed the price of nature-based avoidance credits at $2.75/mtCO2e Jan. 26, down 73% year on year.
"Policy uncertainty, which troubles the compliance market, also troubles the voluntary market. Like what we have observed in the last two years, regulators in project host countries start to ask for better control of everything. This has already affected project investments and trade flows," another trader said.