Queensland University of Technology
together with S. Borak, W. Härdle and R. Weron
Convenience Yields for CO2 Emission Allowance Futures Contracts
Abstract: In January 2005 the EU-wide CO2 emissions trading system (EU-ETS) has formally entered into operation. Within the new trading system, the right to emit a particular amount of CO2 becomes a tradable commodity - called EU Allowances (EUAs) - and affected companies, traders and investors will face new strategic challenges. After a short period of spot trading only, since recently also future contracts with different maturities are offered. In this paper we investigate the nature of convenience yields for CO2 emission allowance futures. We conduct an empirical study on price behavior, volatility term structure and correlations in different CO2 EUA contracts. Our findings are that the market has changed from initial backwardation to contango with significant convenience yields in future contracts for the Kyoto committment period starting in 2008. We further provide stochastic models for the level and volatility of convenience yields. We conclude that the yields can be interpreted as market expectation on the price risk of CO2 emissions allowance prices and the uncertainty of EU allocation plans for the Kyoto period.