An Empirical Study Of The Convenience Yield In The Second Phase Of The EU ETS

The European Union Emissions Trading Scheme (EU ETS) was created on January 1st, 2005 by the European Union to foster early compliance with the greenhouse gases emissions reduction targets agreed in the Kyoto Protocol. As such, the EU ETS covers up to 46% of CO2 emissions from European energy-intensive industries. Every year, each industrial plant is allocated EU allowances (EUA) corresponding to its cap and must restitute as many allowances as verified CO2 emissions. The EU ETS has now become the largest and most active carbon trading program in the world.The goal of this paper is to present important results on the relationship between spot and futures prices in the EU ETS through the investigation of convenience yields and their components. For this purpose, we replicate the methodology used in Uhrig-Homburg and Wagner (2009)[30] and Trück et al. (2006). Both papers study the convenience yield of EUA futures using data available during the first phase of the EU ETS. The added value of this research relies in updating these results with more recent data. Indeed, during Phase I of the EU ETS (from 2005 to 2007), the market was still very immature, sometimes displaying extreme price behaviors and high volatility. For this reason, we feel it might be more relevant to readopt previously used models and methodology and test it against updated and more realistic data.To our knowledge, only one other article has ever used spot and futures prices from the second phase of the EU ETS (from 2008 to 2012). Moreover, empirical studies on the convenience yield in commodity markets, and even more in the carbon market, remain scant. The goal of this research was threefold: using Trück et al. (2006)'s results and methodology, we first investigated the changing market dynamics through the study of the futures and volatility term structures of EUA and found a market in clear contango. Second, we provided an empirical analysis of the EUA convenience yield in the EU ETS and studied its dependence on factors such as the spot price level and volatility. We observed sharp differences in behavior between futures for early maturities (2008 and 2009) and for later maturities (up to 2014). We also found that the convenience yield was positively correlated to the spot price but negatively correlated to spot volatility. Finally, following the Engle-Granger two-step method used in Uhrig-Homburg and Wagner (2009), we proved in a VECM framework the existence of significant cointegration relationship between spot and futures prices with low speeds of adjustment for longer maturities contracts.