Back to the futures

Three factors will determine whether ASX's new environmental futures contracts are a success

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The Australian Securities Exchange (ASX) has announced that it will list three environmental futures products “designed to support Australia and New Zealand’s decarbonisation efforts and energy transition toward net zero.”

The three contracts cover Large Generation Certificates (LGC’s), Australian Carbon Credit Units (ACCU), and New Zealand Units (NZU). It currently plans to launch the futures contracts at the end of the month (scheduled for 29th July), subject to regulatory approval.¹

ASX hope that liquid environmental futures contracts will “provide a transparent forward curve for the market to hedge and price the energy transition”, enabling “capital to flow from those making the net-zero commitments into the hands of those with the ability to reduce and remove carbon.”

In addition to the price transparency and liquidity benefits, ASX also highlight the benefits of immediate execution and confirmation, reduction of counterparty risk, centralised clearing and risk management, and collateral management and operational efficiency.

Futures contracts are a long-standing feature of compliance carbon markets such as the EU, UK, and California ETS. The contracts are used by utilities and other obligated emitters to manage their risk, and by banks, hedge funds, and others seeking to speculate on the price of carbon (see The arc of carbon’s curve: What does the carbon futures curve tell us and why is it important?).

More recently, futures contracts have also become more commonplace in the VCM. For example, the CBL Global Emissions Offset futures contract was launched by the CME in 2021. The exchange subsequently launched two other VCM futures contracts during the following two years.

Regulators are beginning to catch-up with the burgeoning demand for risk management in the VCM. For example, in December 2023 the US Commodity Futures Trading Commission (CFTC) issued proposed guidance regarding the listing of carbon credit futures contracts on CFTC-regulated exchanges.

Build it, but will they come?

Simply because an exchange launches a futures contract doesn’t mean it will be successful in delivering on its promised benefits. Futures contracts don’t always succeed. According to Hilary Till of Premia Capital Management there are three factors that determine whether a futures contract succeeds or not:

1. There must be a commercial need for hedging;

2. A pool of speculators must be attracted to a market; and

3. Public policy should not be too adverse to futures trading.

A commercial need

Most successful futures contracts have emerged to deal with new risks. For example, the breakdown in the structure of the oil industry during the 1970’s caused a shift from long-term contracts to the spot market.

The volatility meant there was a commercial need for a means to hedge price risk. In response, the New York Mercantile Exchange (NYMEX) launched a suite of energy futures contracts, starting in 1978 with the heating oil contract.