EU Allowances (EUAs) are a form of carbon allowance used as the main currency in the EU Emissions Trading Scheme (EU ETS). The EU ETS is a form of Carbon Emissions Trading Scheme whereby total emissions are capped, carbon credits are allocated (freely or by auction) and companies are allowed to trade those carbon credits between themselves. This, theoretically, results in companies competing to reduce emissions and ultimately to the cap being met by reducing emissions at the lowest total cost. EUA carbon trading is global with companies around the world actively participating in the market however the majority of trading, as would be expected, comes from companies within Europe. Carbon trades in European business hours but to keep both continental European utilities and London based companies happy these run from 7am to 5pm GMT.
The majority of EUA carbon trading takes place on exchanges, with the Intercontinental Exchange (ICE), by far the most liquid for EUA carbon trading. There are also contracts listed on the Chicago Mercantile Exchange (CME) and NASDAQ*. Due to a quirk of history annual EUA contracts with the most liquidity settle in December of each year and maturities run out as far as 2020 with the prompt year seeing most action. Good liquidity means tight bid / offer spreads and results in lower transaction costs for companies participating in emissions trading. Spot, monthly and quarterly contracts are also available but they suffer from less liquidity and consequently bids and offers can be far apart. The exchange listed EUA contracts are ‘physical’ contracts which means the appropriate number of allowances must be physically delivered to or received from the exchange to complete settlement. Over-the-counter (OTC) trading (whereby companies contract directly with one another and use bespoke contracts) is also common, however due to the additional counterparty risk with OTC trading and the relative ease of exchange trading, the majority of EUA trading takes place on the exchange.
Participants in EUA carbon trading, either directly or through intermediaries, range from large electricity utilities to investment banks all the way to the smallest industrials and individual retail investors.
