CF Partners launches carbon hedge fund

CF Partners will engage in both long and short selling

Environmental finance firm CF Partners is to start a hedge fund targeting the carbon market. Due to start by the end of January, the fund will exploit the volatility in the carbon markets to make profits, say executives.

The London-based company will run the hedge fund using arbitrage trading, which exploits mismatches in pricing. This will help it to operate with limited leverage, so that extensive funds do not have to be borrowed to amplify returns. Arbitrage trading in carbon could involve finding pricing disparities between two types of carbon credit, for example: the European Union Allowance credits traded under the European Trading System and the Certified Emissions Reduction credits provided by the Clean Development Mechanism.

Company partner Simon Glossop believes that carbon credits have matured to the point where they can be traded effectively as financial assets in their own right, rather than simply as a necessary tool for compliance purposes.

"There has been a huge expansion in terms of transaction volumes on these exchanges, which is an indication of how the market has changed," he said.

Glossop also hopes to mix traditional “long” approaches to carbon trading with a “short” approach, which he said has been far less common in the carbon markets to date. Short selling involves selling financial instruments before they are owned to capitalise on falling prices.

Other techniques include trading other energy commodities based on the firm's knowledge of carbon. For example, if coal costs fall, then the firm may infer that plant emissions will rise, which will have an effect on utilities' carbon hedging strategies. If the cost of power is seen to be less than the combined costs of power and carbon, the fund may decide to buy power and short coal and carbon.

Glossop said that companies forced to purchase carbon for compliance purposes may benefit from participation in the fund in addition to institutional investors.

"Because the fund is a trading relative value arbitrage fund, it will give investors an advantage in terms of information about what's going on in the marketplace," he concluded. "For some of the utilities and other players in the marketplace, it will be advantageous to see what's going on."