Why Now Is a Great Time To Launch US Environmental Contracts

11/12/2018

CHICAGO 

By Jim Kharouf

In today’s markets, there may not be a better time to get into carbon and renewable energy certificate (REC) contacts. This may surprise some but there is good reason these markets are ripe for growth.

Given today’s headlines, a renewed focus on coal and exponential growth of fossil fuel production via fracking, you might think this idea isn’t so great. But there are some surprising and compelling trends to support exchange-traded carbon and REC futures markets now. For starters, renewable energy accounted for half of the increase of new electricity generation in 2017, according to the International Energy Agency. And by 2023, the IEA forecasts that renewable energy will represent about 30 percent of total electricity generation worldwide.

In the US, net greenhouse gas emissions dropped 11.1 percent from 2005 to 2016, from 6.2 billion metric tons of CO2 to 5.4 billion mtCO2, according to the US EPA, while real US GDP (inflation adjusted) rose 17 percent during that time. No doubt, the drop is due in large part to the switch from coal to natural gas electrical generation. Yet, there is also worth looking at the growth of renewables in the US, where wind and solar generation continue to grow, according to the US Energy Information Administration. Last year, the EIA estimated US wind generation at 697,000 megawatt hours per day, and forecast that sector to rise 8 percent to 750,000 MWh/d in 2018, and 793,000 MWh/d next year. Solar power, while smaller than the wind sector, is expected to rise 26 percent from 211,000 MWh/d last year, 267,000 MWh/d this year and 305,000 MWh/d in 2019.

One more statistic worth noting is that US electricity sector emissions have fallen 25 percent since peaking in 2005 (from 2.4 billion mtCO2 to 1.8 billion mtCO2), while real electricity prices have stayed nearly constant. In other words, there is a lot going on in the renewable space today as well as in the US and European emissions markets.

Given this backdrop and these massive shifts in power generation, Nodal Exchange and its partner IncubEx, are jumping into these growing and evolving US markets with the launch of: California Carbon Allowances, Regional Greenhouse Gas Initiative Allowances, New Jersey Solar Renewable Energy Certificates and PJM Tri-Qualified Renewable Energy Certificates and others on November 16, pending regulatory approval.

The State Of The Market

To understand where these markets are, it is helpful to look at the broader market evolution. For starters, US states continue to lead the way on environmental markets beginning with the Regional Greenhouse Gas Initiative (RGGI), launched in 2009. It includes nine northeastern states with New Jersey about to rejoin, and Virginia looking to connect in some capacity as well. RGGI also readjusted its carbon targets with a goal of 30 percent reductions of emissions by 2030 from power utilities in RGGI states.

Meanwhile, California’s carbon market, the fourth largest globally, extended its cap-and-trade program to 2030, corresponding with RGGI and the EU Emissions Trading Scheme. It also has set a goal of lowering its emissions to 40 percent below its 1990 level by 2030. California is also part of the Western Climate Initiative, which includes Quebec and Nova Scotia. Ontario has pulled out of WCI but other states have shown interest in joining, namely Washington and Oregon and perhaps Mexico, which is launching its own carbon market.

And US REC markets are even more geographically distributed with 29 states and the District of Columbia running renewable portfolio standards for solar, wind and other renewables, according to the North Carolina Clean Energy Technology Center.

Good Environment

With certainty now locked in, the market has shown greater signs of growth in terms of volumes and participation. Nodal and IncubEx aim to catch that trend and bring in more participants. While utilities and commercial firms are compelled to participate in local carbon markets, there is a growing number of proprietary trading firms, hedge funds and others interested in them for a variety of reasons. For starters, carbon and REC markets are non correlated to broader equity and bond markets. And in today’s volatile and event-driven markets, holding assets that are non-correlated with stocks and interest rates is considered true diversification and sound risk management.

Having a robust ecosystem of trading participants is another good sign for any market, as it supports a diverse view on prices, adds depth and liquidity and ultimately makes for a more efficient marketplace in which to buy and sell. These markets also complement more than 1,000 electric power futures and options contracts offered on Nodal, where the exchange holds a 30 percent market share of open interest in U.S. monthly power futures volumes.

Nodal is also offering a few technical advantages as well for market users such as portfolio margining, which offers market participants a more efficient way to calibrate and manage risk. Nodal has had portfolio margining in its Nodal Clear clearinghouse for years, and it has proven effective in lowering capital allocations for firms. Adding environmental products to the mix will create even more capital benefits.  

Nodal also worked on providing an efficient physical delivery process for participants — streamlining this laborious process will save firms time and money.

Ultimately, these markets have been resilient, tested and improved over the years. They are primed for increased growth and provide commercial and trading firms with another asset class to hedge and trade. Now may be the best time to date.