How to Trade EU Carbon Credits
By Stéphane on 27/09/2023
Trade European carbon credit futures through Equiti.com, an award-winning global CFD broker. To the best of our knowledge, Equiti is the only CFD broker to support trading in carbon credit futures.
Should you invest in carbon credits through Equiti? We make the case for and against below. As always, be mindful that markets can move against you in often unpredictable ways. Size your positions accordingly, and manage your risks accordingly. Capital preservation is one of the keys to investing success.
The Bull Case
Market is in a structural deficit
Market prices are driven by the balance of supply and demand. Prices tend to rise whenever demand grows faster than supply, or supply falls faster than demand. This is true of any market.
Surplus carbon allowances started to build up in the aftermath of the 2008 global financial crisis and ensuing recession(1). For many years, the EU's Emissions Trading Scheme (ETS) experienced an over-supply of carbon credits. In turn, this kept their price artificially low as credits were plentiful.
However, the EU took steps almost a decade ago to correct this imbalance, in order to penalise polluters and encourage a reduction in emissions. In 2015, the EU established a mechanism known as the Market Stability Reserve to remove surplus allowances. In 2020 alone, this mechanism reduced the auction volume by 35%(2).
Fundamentals are in place for a long-term bull market, as demand rises even as supply falls, driven by the EU's more ambitious emission reduction targets. In 2021, the EU sought to open its Emissions Trading Scheme to a wider range of industries and pollutants, thereby pushing demand for carbon credits higher. It also announced that it would reduce allowances by 2.2% a year (up from 1.47% previously), further constraining the supply of credits.
War in Ukraine
The war in Ukraine and sanctions on Russian energy exports also contributed to higher prices, by prompting German industry to switch over to coal, from gas. As coal emits twice as much climate heating carbon dioxide as gas, industry had to buy more carbon credits to offset its emissions.
The Bear Case
The European market for carbon credit is a heavily regulated market, where demand and supply are shaped by public policy. Until now, the EU's focus has been on reducing emissions through higher prices. The war in Ukraine has driven prices higher than many expected, prompting demand destruction. A recession could prompt governments to relax the supply of carbon credits in an effort to support jobs.
Energy and commodity markets are highly cyclical, with prices set by the marginal buyer. An economic slowdown will lead to lower prices across the energy complex, as demand contracts. As the supply of carbon credits is relatively unresponsive to changes in demand, the price of carbon credits will experience heightened volatility. This isn't a market you want to go long on the verge of a recession.
As is the case with all commodity markets, you'll be trading futures through Equiti rather than the physical commodity itself. This is perhaps easier to understand with oil, when traders buy and sell futures on the price of oil at a future date, rather than physical barrels of oil. This means you'll need to have a view on the future price of carbon credits, rather than the spot price.
If you’re ready to trade carbon credits, why not open an account today on Equiti.com. Equiti is a regulated broker, headquartered in Dubai. Customer service is available 6 days a week in English and many other languages.
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About the author
I'm Stéphane, a trader and an entrepreneur. My mission with TrustedBrokers is to help you find the right broker for you, whether you're a beginner or a pro. I've personally used and tested the brokers on our service, opening and funding real-money accounts, contacting customer service and placing trades. I started my career in investment banking in London.
- 1. Financial Times. (2018). EU carbon allowance market to shake its over-supply problem. https://www.ft.com/content/15f8e290-46d0-11e8-8ee8-cae73aab7ccb
- 2. European Commission. (2020). Carbon Market Report: Emissions from EU ETS stationary installations fall by over 9%. https://climate.ec.europa.eu/news-your-voice/news/carbon-market-report-emissions-eu-ets-stationary-installations-fall-over-9-2020-11-18_en