Trend-following and inflation protection

Can CTAs hedge inflation risk?

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If you ask the traders of energy complex, it’s been a wild ride this last couple of sessions. Natural gas and carbon certificates in particular have been zig zagging in a seemingly unpredictable manner. Speaking about the carbon price, it’s worth mentioning that on Tuesday EUA spot (approximated by daily futures, ICEDEU3 Index on Bloomberg) dipped by full 4€ from 58€/t to 54€/t. You don’t see that every day. What was the catalyst? Well, that’s the story we’re going to tell you this morning.

So far in the last few months EUA spot (European Union Allowances, carbon emission certificates traded on EU ETS) closely followed the natural gas price – you can look at TZTX1 Comdty on Bloomberg, for instance. Higher gas prices are a metanarrative of the story about higher EUA and in contrast to popular opinion that tight(er) Russian supply to Europe is behind most of the price surge, we offer a different angle to the story that is instead focused on Asian LNG buyers. Just last winter a unique meteorological phenomenon called La Nina brought about exceptionally cold weather to northeast Asia, leading some countries (Japan in particular) to boost natural gas spending for heating purposes. The timing of La Nina couldn’t have been worse because Japanese nuclear power plants operated at lower capacity, meaning that natural gas had to be used both for heating and energy production. In order to fill the gap, Japanese companies had to buy natural gas on the spot market, pushing prices to an all time high. Well this year the same companies were instructed to build stocks in order to have a buffer in case of extreme weather event.

As a matter of fact, National Oceanic and Atmospheric Administration (NOAA) has estimated the probability of La Nina happening all over again in November 2021 – January 2022 at 79%. With this in mind Japanese power agency (OCCTO) released a warning in April for power companies to stock up supplies early on so that detrimental effects of winter 2020 don’t happen all over again again. And stockpile they did – in September 2021 Japanese LNG stock was up by +54% compared to a year earlier (2.5mm t in September 2021 versus 1.62mm t a year earlier).

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Quantica Capital
May 25, 2021