The first auction of greenhouse gas allowances in Ontario will be held on March 22nd, 2017. Mandatory and voluntary participants to the Cap-and-Trade program must apply no later than February 21st if they wish to participate. If you feel uncomfortable with the whole auction process, well, you’re not alone. It will be a first for most participants (only a few have experience in participating at auctions in Quebec and/or California). Based on our experience in developing Cap-and-Trade compliance strategies and from discussions with experienced participants, here are a few hints about what NOT to do at this first auction.
1. Postpone participation
Even if you’re not 100% ready, even if you would like to clarify or assess or refine your Cap-and-Trade strategy, you should participate. Unless you are very confident that the Canadian dollar will strengthen against the American one, bringing the reserve price down, you should expect to observe the lowest settling price at this first auction. The Ontario market is still reserved for Ontario participants and the various players (capped and opt-in) are simply not ready to be active during auction. These factors are reflected into a limited number of participants and a expected low demand for Ontario allowances; kind of an early-birds discount for those who participate.
2. “We’re here to learn” attitude
Many see this first auction as an opportunity to learn. While there is indeed no better way to learn, this attitude often comes along with a defensive approach and a “we want to avoid any possible mistake” position, leading to underbidding in terms of both price and volume. Opportunities on the market don’t come and go. If you’re not ready to seize it now, it won’t return. There is nothing like good preparation and planning ahead to feel comfortable at this new game.
3. Place a single bid
Many participants lack a Cap-and-Trade strategy. It especially becomes evident at auctions, where they perform a simple calculation based on their available budget and on the number of allowances they need, and then present their bid price. This is a risky approach that might affect various participants on their first auction if they underbid and are ultimately left with no allowance at all. Fortunately it is a common mistake participants usually make only once. True, many claim they can’t afford to pay a premium of $1 or $2 above their expected or budgeted price; but then realize that being left with an empty allowance account is not a good outcome either.
A smart bid strategy would include a few bid steps at different price points. Five volume/price combinations is a good starting point, but really, the more the better. This way you secure part of the required volume and – with the right long-term Cap-and-Trade strategy – you will have the ability to adapt and find other opportunities.
4. Bid only on current vintages
In most cases it is already complicated enough to deal with current obligations, why should we bother with future emissions and allowances?
Well, most participants understand the financial advantage of purchasing allowances of future vintages, but it is somewhat more difficult to establish the needs for allowances to cover future GHG emissions in the following compliance period. Still, it is worth the extra mile to forecast future production levels, GHG emissions, free allowances, etc.
Bidding in the Advance Auction should be considered, especially in the coming auction where allowances obtained from Current (vintage 2017) and Advance (vintage 2020) Auctions can both be used to cover emissions of the first compliance period in Ontario. This means that you essentially have two simultaneous opportunities to acquire allowances at reasonably low price for the same regulatory obligation. It is a rare opportunity that only comes in the initial year of launching the Cap-and-Trade.
5. Plan one auction at a time
We’ve seen Cap-and-Trade participants nervous at each auction, missing out on opportunities and struggling with compliance and cost management. The reason behind this was very often a lack of planning. Really, the single most important mistake that drives the cost of compliance up for a given participant is the recurring focus on the next coming auction. Only a long-term vision and solid plan, combined with the ability to go on the market outside the quarterly auctions, will enable you to develop an efficient Cap-and-Trade strategy that generates savings and minimizes risks.