Beware the algorithms ‘robo-herding’ the EU carbon market

“People no longer are responsible for what happens in the market, because computers make all the decisions.”

- Michael Lewis, Flash Boys

It is easy to ascribe human logic to daily, or even intra-day movements in financial markets - especially for financial journalists, since that is their job.

However, much of the movement we see may actually be the result of bots - automated programs designed to buy or sell based on pre-determined criteria. Increased complexity means that it is no longer possible for humans (at least on a very short time horizon) to compete with automated programs designed to make split second decisions.

In 2019, the US Commodity Futures Trading Commission (CFTC) published a report outlining the extent of automated orders across eight of the CME’s futures markets including currencies, equities, financials and commodities. The percentage of automated orders as a share of the US futures market had increased across all eight markets between 2013 and 2018, but it was especially pronounced in the energy and commodity markets. The average percentage point increase in automation was 19% over the 5 years, resulting in between 65% (livestock, oilseeds and grains) to 80% (energy and metals).

Photo by Ian Battaglia on Unsplash

The need for rapid decision making is even more acute in those commodity markets that require real time balancing and involve numerous intra-day markets, such as the European power market. By extension this affects pricing in the natural gas, thermal coal and carbon allowance markets.

Although it’s difficult to be precise about their share, algorithmic trading has also been aggressively deployed across Europe’s energy markets. As of 2020 some of the continents power spot markets reported that over 65% of trades are performed by algorithms - up from less than 10% at the end of 2015. That share is likely to have increased in the past couple of years as the degree of complexity has risen.