European Union Allowances (EUAs) spot and futures contracts differ in their financial structures and trading characteristics. Direct participation in the European carbon market as a policy tool is only possible through spot investments.
EUA futures contract are financial derivatives
Futures contracts, a reminder
In finance, a futures contract is an agreement between two parties to buy or sell an asset at a predetermined price on a specified future date. This type of contract allows investors to speculate on future price movements or hedge against price fluctuations. For example, a farmer might agree to sell 5 tonnes of corn at $5 per bushel six months from now, locking in a price despite future market conditions. In reality however, futures contracts are often settled for cash rather than through the actual delivery of the asset - there is no actual exchange of the underlying commodity.
EUA Futures Contracts
EUA futures contracts are traded on exchanges such as the Intercontinental Exchange (ICE) or the European Energy Exchange (EEX). Participation in the EU ETS futures market is primarily driven by financial goals. Investors seek exposure to EUA price returns, by adding an asset designed with a structurally decreasing supply. There can be ETFs providing such financial exposure to EUA futures. Also, brokers and trading desks in the EUA secondary market use these contracts as part of their financial strategies, in their role of market makers.
EUA spot contracts form the EU-wide carbon budget
Spot contracts, a reminder
A spot contract is an agreement to buy or sell an asset at its current market price, with immediate delivery. In financial terms, a spot transaction involves an instant exchange of goods or financial instruments based on the prevailing market conditions.
EUA spot contracts
EUA spot contracts can be traded alongside futures contracts on the same marketplaces, but they can also be purchased directly from the primary market when issued by the European Commission. Unlike futures contracts, only EUA spot contracts are the actual financial tool for the decarbonization policy that underpins the EU's climate commitments.
Comparing EUA spot and futures contracts
Most trading activity in the EU ETS currently takes place in the secondary market, with spot EUA transactions making up about 3% of the trades. In the past, spot transactions were mostly used by compliance actors, but there is now an expansion in participation, for example the one coming from private investors seeking proven climate impacts through their investments. Despite the smaller volume of EUA spot trades compared to EUA futures, this does not undermine their liquidity nor the effectiveness of their price discovery.
EUA futures contracts are mostly used for speculation and hedging, while EUA spot contracts are the financial tool used for the EU's carbon budget and policy implementation - each contract has a distinct structure and has a different role in the EU ETS market.
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