4. Relationship between transaction costs and size of participants
Figure 4.1 below shows the relationship in the EU ETS between the number of installations compared to the size of installations in terms of their allocation. As can be seen, there is an uneven distribution of allowances with roughly 90% of the smaller installations (<1Mt/year allocation) accounting for only 20% of the total allocation volume.
This section examines the performance of small and large market participants in relation to their ability to execute transactions and their ability to achieve competitive price levels.
See figure at its full size (including text description).4.1. Costs of trading in the carbon markets
The costs for companies in the EU ETS include annual administrative-based costs (e.g. application and permits, registry accounts, monitoring, verification and reporting) and transaction costs, which can be split into:
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Direct transaction costs – exchange membership, brokers fees, financial services etc;
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Indirect transaction costs – personnel to manage transactions and risk management, data/advisory services, financial reporting etc.
We note that the administrative costs of a trading scheme are effectively set by the legislators and that these costs can be controlled and set appropriately. In this section, we therefore focus on the transaction costs.
4.1.1. Exchanges
Cost of trading at exchanges is normally split between fixed annual costs and a variable cost element depending on the volume of transactions. The fixed element can be a combination of an application/set-up fee and an annual membership fee. The transaction cost is a combination of a trading fee and a clearing fee. Some exchanges add or waive delivery fees in forward contracts depending on physical transfer of the allowances. The table below provides a brief overview of the cost of trading at selected exchanges. We emphasise that the table does not accurately represent the detailed cost structures of each exchange as there e.g. may be optional fee schedules depending on the volume of transactions. Prices change regularly as well and detailed up-to-date price information can be acquired from the exchange websites.
Figure 4.2 Summary of trading fees at selected EU ETS exchanges (as at 12 September 2007)
Per 1000t CO22 |
ECX |
NordPool |
EEX |
|---|---|---|---|
Application fee (one-off) |
€500 – 2,500 |
0 |
€12,000 |
Annual fee |
€2,500 |
€3,000 |
€5,000 |
Transaction fee |
€2 – 2.5 |
€33 |
€1-3 |
Clearing fee |
€1.54 |
€305 |
€3 |
2 Fees for forward/future contracts
3 This includes trading and clearing fee together
4 Requires a clearing membership at LCH Clearnet or agreement with a clearing member.
5 Clearing fee for small clearing customer only
In addition to the fees, exchange members need to make available a certain amount of capital, known as a margin call, to cover the credit risks associated with their investments.
4.1.2. Over the-counter market
The OTC market is less transparent than exchanges. There are numerous brokers operating in the emissions market but six of the most active brokers cover around 90% of the market. Rather than sign a contract for each trade, companies usually sign a master agreement with a counterparty and can then trade freely with that company through a broker, who has a list of companies that can trade with each other. It is mainly the large utilities and trading houses that have master agreements in place.
Smaller players, or companies that want to access OTC channels without a lengthy contract procedure either enter the market through trustees/financial institutions, who provide access to markets and credit lines, or it is possible to use OTC channels without signing master agreements by using clearing. This means that a deal is conducted through the OTC and cleared through a clearing house.
Brokers charge fees as a percentage of the volume traded but there is no transparency in the fee structure. There is a large discrepancy in fees based on the size of the customer and the number of different products traded. Fees are in the range of 0.5 to 2.5 euro cents/tonne and are often negotiable. Given the fact that the market is generally short and there is high demand for allowances, there are often lower fees offered to sellers.
4.1.3. Kyoto flexibility mechanisms
Investing in projects
To receive credits from a project, investors need to be named as a project participant. Depending on the stake in the project this will involve investing a certain amount of capital (this amount is also dependent on the level of upfront cash required for the project). This means that investing directly in projects is often not possible for smaller players. There are also considerable risks, especially investing in projects at an early stage of development, so this means that the investing company should be able to absorb potential losses from defaulting/low-performing projects.
Purchasing on exchanges
Again, there is now a secondary market for issued CER credits, both over-the-counter on several exchanges. The fee structure for trading these products is similar to trading normal EUAs (see above). This market segment is more suitable for smaller players to participate in although the prices of issued credits are higher than for credit purchase agreements at earlier stages in the project pipeline.
Participating in funds
A large number of carbon credit funds are now in operation. These vary considerably in terms of target investors (public or private), cash-return or credit-return, type of credits etc. Many of the funds are open to investors of all sizes (i.e. the minimum investment amount is not too high) although there are some that require significant upfront investments, which would exclude many smaller players. Fees are either based on percentage fees or as fixed management fees (which may disadvantage smaller investments). It is possible, however, for smaller players to participate in funds through a financial intermediary, which may be catered more to smaller investment sums.
4.2. Other transaction routes
Investment banks (financial services) have been quick to move into the carbon markets and offer a wide range of services, particularly for smaller players. Naturally, there are fees involved but profit-sharing contract structures can be set up to ensure that the client receives part of the upside. This may be a better option than just using the financial institutions as brokers as financial institutions may be better placed to make trading decisions and have access to wider market segments. Fees and profit-sharing agreements are non-standardised and are negotiated on a case-by-case basis.
The experience of the EU emissions trading scheme and the Clean Development Mechanism demonstrates that financial institutions are quick to enter such new markets and offer solutions to smaller players. They benefit by aggregating demand in order to achieve economies of scale and/or by charging risk management fees to their clients.
There are other products available for companies including lending part of an allocation to a financial institution to take advantage of differences in values of EUAs between years. In general, financial institutions, who are speculators in the market, are keen to get hold of physical volume and so offer competitive deal structures to participants that can offer this.
Some utilities, who are generally short, also offer bilateral deals with their customers to purchase credits as part of power-purchasing agreements.
4.3. Achieving competitive price levels
As with all commodity markets, larger companies will undoubtedly have larger staff numbers and potentially better analytical capability, which may help them achieve better prices in commercial transactions. However, the carbon market has developed and there is now several years of price history, which gives all participants better information on which to base future forecasts. There are also several data and analysis providers in the market, which give transparency to the market and improve price reporting. In general, as markets develop there is a narrowing of the knowledge-gap between the smaller and larger players.
In addition, the increase in the volumes traded at exchanges means that players of all sizes can see transacted prices at all periods in the trading day, and have access to these quoted market prices in exactly the same way as larger players.
4.4. Summary
Within the EU ETS, there are a large number of small players who only need to trade small volumes compared to some of the larger participants. Brokers’ fees and exchange fees are set up in a way in which the average transaction costs will be higher if volumes are smaller. This is inevitable in any market.
However, the growth of the financial service sector within carbon markets presents many opportunities for smaller players to access the carbon markets indirectly, and to potentially benefit from these companies trading on their behalf. Smaller players hold physical carbon assets that are in high demand from the banks.
The main area in which smaller players may be disadvantaged is the ability to invest in CDM/JI/GIS projects directly (primary project market), as often this requires significant levels of upfront equity. However, it is possible to participate through funds directly or indirectly through a financial intermediary, or to trade in the secondary credit markets. This in turn involves some exposure to price volatility in the EU emissions trading scheme.
Finally, there is no real evidence of larger players being able to negotiate better prices in their deals as the carbon market has become a much more transparent market, especially with the develo
