CEMA 2023: Talk on optimal emission allowance trading for industrial buyers


Jun 20–21, 2023 | Budapest, Hungary

At this years Annual Conference of the Commodity and Energy Markets Association in Budapest, Professor Nils Löhndorf speaks about optimal emission allowance trading for industrial buyers.

In his talk, he discusses a stochastic-dynamic decision model that takes the perspective of a category buyer of an industrial company who buys emission allowances on spot and futures markets to cover for the company’s excess emissions. 

Industrial buyers can use the model to calibrate an optimal buying strategy that accounts for various risk factors, like market risk, quantity risk, and liquidity risk, and that matches the company‘s appetite for risk.

A comprehensive analysis and simulated and historical data that compares the optimal risk-neutral with an optimal risk-averse strategy revealed a few surprising insights. 

Risk-neutral buyers make more use of the futures market than risk-averse buyers. The reason is two-fold. 

1. The futures market is more liquid than the spot market, which leads to lower transaction cost in the form of market impact cost. A risk-neutral buyer therefore simply waits until December and buys the December contract.
2. Emission allowances can be banked for the next compliance period, so that a risk-averse buyer can buy forward using the spot market. Since the spot market is relatively cheaper for a company with low cost of capital, the futures market is not all that attractive for hedging price risk.

In summary, these finding underline the value of a model-driven approach to inform decision-making around emission allowances that efficiently navigates through elements of market liquidity, cost of capital, and price uncertainty. 

Check the conference agenda and scheduled time for the talk here!

Get in touch, if you attend the conference and are interested to meet up! Also feel free to contact us if you can't attend the talk and are interested in the paper and/or the presentation!