What is the Commitment of Traders report in the EU ETS?

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For anyone following carbon markets dynamics, a major event of the week is the release of the Commitment of Traders (COT) report every Wednesday. Essentially, this report shows the behavior of market participants over the preceding week – it says who has been buying or selling, and by how much. This data is important as it indicates whether EU ETS stakeholders are optimistic or bullish (purchasing more) about the short to medium-term outlook of carbon markets, or at the opposite, if the COT report reflects more pessimism, with a bearish trend (selling more).

The Commitment of Traders report distinguishes different categories of market participants - this important as their actions are motivated by distinct objectives and timelines. For instance, while some buy European Union Allowances (EUAs) for compliance (no matter what the price is), others acquire them for price appreciation. Hence, the COT is a tool to gauge the general market sentiment, although sometimes the possible analysis of the data may lack precision or accuracy.

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• What do Commitment of Traders reports show? 
• What is the Commitment of Traders report in carbon markets? 
• What are the benefits from the Commitment of Traders report in the EU ETS?
• What are the limitations of the Commitment of Traders report in the EU ETS

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What do Commitment of Traders reports show? 

How do traders make investment decisions?

I really like the quote “One of the funny things about the stock market is that every time one person buys, another sells, and both think they are astute” from William Feather. Indeed, the free market price of an asset is the level at which market participants agree to exchange that asset. They have different objectives and investment timelines, but eventually are able to reach a consensus on how much a good is worth. Their behavior and judgment depends on where they think the market (and prices) is going. 

Why do we need a Commitment of Traders report?

Being aware of the prevailing market sentiment is crucial before making any investment decisions. The Commitment of Traders (COT) report is a key indicator of the prevailing investor mood within the market. Increased buying activity suggests a more optimistic outlook, while an increase in selling activity indicates a more bearish stance - participants can be anticipating a decline in the short to medium term. By monitoring the COT report, investors can make more informed investment choices.

What is the CoT in financial markets and commodities? 

The Commitment of Traders (COT) report, a weekly publication, gives information on the combined holdings of different groups of market participants. Its origins can be traced back to 1924 when the U.S. Department of Agriculture’s Grain Futures Administration issued an annual report detailing hedging and speculation activities in the futures market. Initially published annually, it transitioned to a monthly publication in 1962. Traders have always used the report to assess whether they should add short or long positions in their trades. Similar reports exist for numerous financial assets and commodities, including 

• natural gas, 
• gold, 
• oil, 
• corn…

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What is the Commitment of Traders report in carbon markets?

What is the European Energy Exchange?

Based in Leipzig, Germany, the European Energy Exchange (EEX) AG is a hub for trading in electric power and commodities across central Europe. It is in charge of establishing, operating, and interconnecting secure, fluid, and transparent markets for energy and related goods. This includes facilitating transactions of power derivative contracts, emission allowances, as well as agricultural and freight products.

Carbon markets, EEX and the Commitment of Traders report

EEX is the primary platform for conducting carbon allowance auctions - it is the source of related data, including auction calendars and daily auction results. Moreover, EEX is the designated venue for publishing the Commitment of Traders report for carbon markets every Wednesday.

What are the categories of the Commitment of Traders report for the EU ETS? 

The CoT report categorizes individuals into five distinct groups based on the nature of their business:

• Investment firms (as per the definition in MiFID II) or credit institutions;
• Investment funds, including those engaging in collective investments in transferable securities or managed by alternative investment fund managers;
• Other financial institutions, such as insurance undertakings, reinsurance undertakings, and institutions managing retirement provisions;
• Commercial enterprises (commercial activities outlined in ESMA guidelines on key concepts of the Alternative Investment Fund Managers Directive Ref. 2013/611);
• Operators subject to compliance obligations under Directive 2003/87/EC (holders of greenhouse gas emission allowances).

What investment data is given by the  EUA Commitment of Traders document?

The CoT report provides aggregated positions, detailing the following for each category:

• Total number of individuals or entities within the category.
• Long and short positions held.
• Changes in positions since the previous report.
• Percentage of open interest represented by the positions within the category.

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What are the benefits from the Commitment of Traders report in the EU ETS?

The Commitment of Traders report and the Mifid II regulation

MiFID II is a regulatory framework for financial markets in the European Union, aimed at enhancing transparency, investor protection, and market integrity. EUAs have been included since 2018, categorizing them as financial investment assets, and enabling for non-compliance entities to take part in the EU ETS. 

The Commitment of Traders report shows market sentiment and trends

The Commitment of Traders report allows to monitor the short-term market sentiment of each category on a weekly basis. But by providing how their positions are evolving over months or years, it offers valuable on more general market views and trends over the long run.

An example of how to interpret Commitment of Traders report data

Before the summer of 2021, investment funds held a "net long" position - they had a preference for buying over selling. However, this trend was reversed after this, as they had started selling more than buying. This shift came along with  the start of operation of the NextGenerationEU package - the predecessor of the RepowerEU scheme. The latter involves “taking away carbon allowances from future budgets” for auction in 2023 and 2024, ultimately leading to a decrease in prices. So, investment funds reacted to this announcement, they started  anticipating a price decline. This was in turn reflected in the reversal of their trend as seen in the CoT report during that period.

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What are the limitations of the Commitment of Traders report in the EU ETS

The EU ETS is a unique market, the CoT is the same for every asset

A concern regarding the Commitment of Traders report is the differentiation between the different market participants. These categories are determined by regulatory rules applicable to a wide array of commodities and financial assets (as discussed above). Yet, European Union Allowances stand out as the participants come from diverse spheres like the industry, investment, and speculation. So, the distinctions in the market participants’ groups in other financial assets may not accurately capture the behaviors within the EU ETS.

Some confusions in the Commitment of Traders report in carbon markets

For example, the Investment Firms or Credit Institutions category encompasses Proprietary Commodity Traders, the latter being way more speculative than the former. Also, the Commercial Undertakings group includes non-regulated traders - again, they have very different investment objectives. It is also difficult to analyze what is going on with Compliance Operators, as there are installations that buy solely for compliance reasons, and others do so for financial returns. 

How can the Commitment of Traders Report be improved?
One potential solution involves restructuring the existing categories or incorporating new ones based on their objectives - a clear distinction between speculation, investment, and the need to match emissions. Also, introducing more numerical values, such as energy consumption or CO2 emissions over the period can be helpful. Finally, more information on positioning information like EUA futures and spot, could enhance the comprehensiveness of the report.

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