CARBON FINANCE089Commission Regulation (EU) no 1031/2010 of 12November 2010 on the timing, administration andother aspects of auctioning of greenhouse gasemission allowances pursuant to Directive2003/87/EC of the European Parliament and of theCouncil establishing a scheme for greenhouse gasemission allowances trading within the Community.)In the last year of the second clearing period (Phase II)the introduction of "trial" auctions has beenannounced. The auctions will trade in allowanceswhich can be used in the third clearing period (PhaseIII), 120 million of allowances in total. The advantagesof such an experiment include an opportunity to testthe functioning of the system, preparing companies forincoming change as well as certainty of obtaining unitsneeded in Phase III. However, a few issues related to the validity ofallowances held by companies from Phase II remainsomewhat unclear. EU Directives account for suchconversions but the way of calculating their value hasnot as yet been decided. It is expected that theconversion factor will be used by the EuropeanCommission as a means of controlling the supply ofallowances in subsequent periods which shouldcompel companies to participate in the trial auctions. Sales of allowances at auctions will either take theform of two-day spot or five-day future contracts.Which of these two options will be used will be decidedduring the process of appointment of the commonauctioning platform. For auctions held before 2013,allowances EUA valid for the period 2013-2020 willbe sold in the form of forwards or futures with an optionof delivery before the end of December 2013. Theform of contract will be decided by Member States.One of the advantages of the use of auctions is the factthat all parties will have access to CO2 emissionsallowances on equal terms. According to Directive2009/29/EC, allowance auction should also guaranteeopenness, transparency and cost-effectiveness.Another definite advantage is the fact that individualcountries will be able to dispose freely of revenue fromsales of allowances at auctions. At least 50 per cent of income from the sale ofallowances at auction is intended to be used to fundenvironmentally-friendly investments such as thoseproposed in Art. 10 of the Directive of the EuropeanParliament and of the Council 2009/29/EC of 23 April2009 amending Directive 2003/87/EC so as toimprove and extend the greenhouse gas emissionallowance trading scheme of the Community. Nevertheless, purchasing additional CO2 emissionallowances after 2012, particularly in the light of thecontinuing financial crisis, will pose a considerablechallenge. A growing market interest in futures (i.e.contracts with delivery occurring at a specified future

date but at a price agreed at the time of entering into theagreement) indicates that in the case of installationsthis particular way of purchasing allowances willconstitute a significant proportion of all transactions. This form of purchase will allow buyers to delay, to acertain extent, the costs involved in buying allowanceswhile securing the price which, given the predictedfuture shortage of free allowances within the UE, ishighly likely to increase in the coming years. It isimportant to remember that upon entering into such acontract parties are only required to pay the financialinstitution involved a deposit (a margin) which securesfuture fulfilment of the contract by the parties. Thisusually amounts to 20-25 per cent of the contract'svalue and can change throughout its duration. So it ispossible to buy allowances with delivery, say, in a year'stime and pay only 20-25 per cent of their value todayand the remainder a year later. The possibility of transferring a significant part of thecost of acquiring allowances forward in time seems tobe of the utmost importance to energy companiesoperating in a regulated market, who will not be able tooffset the full cost of allowances against the price atwhich they sell energy on a regular yearly basis. An increasing number of companies wishing to avoidthe problem of time-variable deposits make use ofoptions on allowances. Here the buyer of allowancespays a non-refundable option premium, often similarto the amount of the deposit payable in futurescontract. Option contract is more advantageous to thebuyer in the sense that the deposit is required only bythe seller and if the price increases the buyer is assecure as in the case of futures. However, if the market price of allowances at expiry islower than the price previously agreed (after includingthe premium paid), the buyer can withdraw from thecontract and buy allowances on the market, in otherwords cheaper. Hence additionally, this option reducesthe price of allowances in real terms. Another equally important issue is estimating thenumber of allowances that need to be purchased in theform of futures and related contracts to cover a givenyear. In order to do this, one needs to calculateprecisely the future volume of CO2 emissionsaccording to predicted sales volume of a product orservice. In the case of energy sector, predictionsconcerning emissions are, in fact, predictionsconcerning temperatures in the coming year - a taskalways prone to a large margin of error. For this reason, there is an increasing market interestin futures contracts on allowances with flexiblevolume. These contracts, called "quantos", usuallyinvolve paying a deposit in the same, or slightly higher,amount than in the case of standard futures contracts.In the case of quantos the price of allowances is setupfront but the volume of purchase is not, as it isconnected to air temperatures in such a way that in thecase of a cold winter the buyer does not need to worryabout buying additional, often more expensiveallowances. This way, a party purchasing emissions inthe form of futures contracts with flexible volumelimits the risk related both to the price and the volumeof purchase in a given year. This allows the buyer tocalculate upfront the total cost of participation in theemissions trading system. nABOUT THE AUTHORMaciej Wisniewski is Co-Founder and President ofConsus S.A. - a leading organisation in the field ofemissions trading and weather derivatives in Poland.In the early 1990s Mr Wisniewski created twobrokerage houses, which are now the largest of theirkind in Poland, and in 1999 he co-created the PolishOpen Pensions Fund. Mr Wisniewski has also been anadviser to the Polish Government on the issuesrelating to the EU ETS and the creation of relevantlegislation in Poland. He holds degrees from NicolausCopernicus University in Tourn, Poland, andDominican University in Chicago. 090CARBON FINANCEPhoto: UN Photo/Kibae Park" "THE POSSIBILITY OFTRANSFERRING A SIGNIFICANTPART OF THE COSTOF ACQUIRING ALLOWANCES FORWARD IN TIMESEEMS TO BE OFTHE UTMOST IMPORTANCE TOENERGY COMPANIES