(B.) Advanced Structures
Below we begin to outline some of the most widely used financial structures.
Forward Settlement
This type of transaction is much like the immediate settlement example
discussed previously. The delivery of allowances and payment, however, happen some time in
the future, as the name indicates. These types of transactions allow market participants
to lock in future purchases at prices that meet their individual needs. It is also a sound
tool for managing cash flow, as the buyer is able to book the definitive price of the
future purchase well in advance.
Short-Term Forward, Long-Term Forward
The market has derived a few innovations to the forward settlement structure in order to satisfy varying needs. Buyers who are looking to lock in prices through a forward deal—but want to do so within a year—can transact a short-term forward. Usually, delivery and payment are scheduled for December, when utilities true up their emissions balance sheets.The long-term forward typically extends settlement date by several years, and this type of settlement is contracted by adding on the seller's cost of carry. The cost of carry calculation essentially means the buyer will pay the seller a premium over the actual cost of the allowances in return for the delay in payment and delivery. In mature commodity markets, forward transactions are quoted prices much like spot transactions. However, the forward emissions market is too thin to have standing bids and asks, so a carry forward calculation is used instead.
Carry Forward Calculation Formula
[(current allowance price) x (allowance loan rate)] + current allowance price = forward contracting price
For example, if SO2 vintage 2001 allowance prices are quoted at $100 dollars in July 1999, but a utility is interested in purchasing allowances for delivery in July 2001, the contract price would be $122.50.
i.e. [($100/allowance) x (7%)] + $100/allowance = $107.00/allowance (compounded yearly for three years: $122.50)