Exclusive Interview: Nathan Clark, Managing Director at IncubEx talks about the launch of the first physically delivered LCFS futures contract

The Nodal Exchange marked its maiden entry in the environmental markets in November 2018 with the launch of its carbon and Renewable Energy Certificate (REC) futures. Nodal Exchange along with FreightWaves and DAT® launched the world’s first Trucking Freight Futures Contracts in March 2019. A year from then, Nodal is set to mark its presence into the LCFS market with its first launch on January 31st, 2020. Nodal has also been the winner in the ‘Energy Risks Awards, 2019: Commodities Exchange of the Year with record volumes of power futures traded.

CaliforniaCarbon.info Thank you for agreeing to talk to us and extending your views with our readers. It has been an exciting week looking into the new launch of the LCFS futures and options contracts scheduled for 31^st of January 2020. Can you tell us some more about it?

Nathan: The contract will launch on the 31^st of January 2020. The product includes LCFS futures contracts as well as options. These contracts will be physically delivered futures. So, buyers and sellers entering the trade will be transferring LCFS credits via the LCFS Reporting Tool and Credit Bank & Transfer System (LRT-CBTS) for positions held through expiration of the futures contract That is the unique feature of the product and consistent with other liquid environmental futures products we have developed historically. The contract size is a 100 LCFS credits per contract. Participants would be able to trade the product on the screen or transact via a broker and clear as a block trade on Nodal Clear. So, it would be fairly similar in structure to our existing CCA contract and the delivery mechanics are similar as well.

CaliforniaCarbon.info: We believe our readers would like to know which futures contracts will be available for trade and how often will they be released annually.

Nathan: The first delivery month will be March of 2020. We will then have monthly deliveries out through Dec21 and following that, we will have a December delivery each year out to 2030. And it is sort of a rolling 24-month period as we get closer towards the end of it. This year we will roll out another 12 monthly expirations.

CaliforniaCarbon.info: We understand that Nodal Exchange will introduce options trading as well. Should we expect spread trades and block trades as well?

Nathan: We expect that to be the case I think that will be one feature that the market would find useful. There will be options on futures on the table as well. We hope to see people taking advantage of the full suite of hedging tools.

CaliforniaCarbon.info: It is very interesting to see Nadal’s progress in the commodities market. Could you tell us the reason you decided to venture into the LCFS market?

Nathan: It was based on customer feedback and a natural extension of the work that we have been doing over the last couple of years. The bulk of our work in the environmental markets has been in renewable energy certificates (RECs) and in carbon markets, in both California and in RGGI markets, and we have LCFS which is expanding in both US and Canada. Therefore, it seemed like a logical place for us to plant our flag. And many of the same entities that trade in California Carbon Allowances or other environmental products on the Nodal Exchange are also trading LCFS. So, it was a logical next step for us.

CaliforniaCarbon.info: 2019 has been a very eventful year for the LCFS space. Especially Q4 2019 CA LCFS credit prices ranged at an all-time high. In December 2019, regulators mentioned CARB will continue to look into strong LCFS targets beyond the current 20% by 2030. What future do you envisage about the LCFS market?

Nathan: Our hope and expectation is that these programs will continue and proliferate. We’ve seen a program that is now active in Oregon and the Canadian government has a national program that they are implementing. There’s talk about LCFS in the Northeastern US and just recently, there was a proposal for an LCFS program in the Midwest, along with Washington, New York and Colorado considering programs. We think that there’s a strong future, a bright future for LCFS in US and in Canada. And we hope to be able to play a part in these programs.

CaliforniaCarbon.info: What is the volume of transaction that you will be expecting in the first year. Is there an expectation that you’ve kept?

Nathan: We don’t have firm numbers to put on it. But we have seen the volume of LCFS trading grow over the last few years. The LCFS program trades roughly averaged out, 10 times a day. I would hope that adding physically delivered futures and options would expand that opportunity, whether or not we capture a very small portion of that. I can’t say much at this point because we haven’t started. I think we’ll probably start small and keep growing as we have in any other products that we have posted.

CaliforniaCarbon.info: Fuel transactions from providers of low carbon fuels for each calendar quarter and reported in the next calendar quarter (Jan-Mar – reported before June 30^th). One would expect higher volatility in the contract in the contract which are expiring just after the report is due. There will be certain price volatility which would deviate from the fundamental price driver in commodity markets, which a lot of analysts say is the balance between the physical production and consumption of a commodity. For an exchange, are there some mechanisms in place to control such price fluctuations.

Nathan: I think there are a few items to note there. One, the California Air Resources Board has put in some speed bumps if you will, or price caps on the product itself. LCFS has a firm price cap associated with it. Additionally, they have the credit clearing market where you can go in and buy directly from CARB if prices reach the ceiling. But I think you know, more to your point, in the early days of the market there may have been more price volatility around the issuances of credits. I personally have not looked at the volatility numbers on those days. You would expect, going on a decade of this program being active that the number of credits out in the marketplace has grown. The number of participants has grown, the market itself has matured in such a way that people are probably more planful now in the way that they address their compliance issues and their issuances. So, we haven’t really seen much in the way of extreme price volatility in LCFS for quite some time. Although, it has been hovering around the range of the ceiling price for quite a while. In terms of volatility, while it certainly is there, I wouldn’t characterize it as extreme for LCFS right now.

CaliforniaCarbon.info In an earlier interview with CaliforniaCarbon.info, we got to know that your business model is feedback oriented. Were the LCFS contracts launched as feedback to the response by stakeholders in the market and a possible market development on a substantial scale?

Nathan: We have been engaging with stakeholders in the design of the LCFS contracts for over a year now. The feedback that we received indicated a physically delivered contract and therefore we went in that direction. We did stick with that model and have continued to engage with market participants to see what it is they feel would really help them mitigate risks in this market. In this case, it was a physically delivered LCFS contract.

CaliforniaCarbon.info: Will Nodal and ICE ever consider a linkage for contracts with mutual recognition in the future?

Nathan: I really can’t speak as to what they will or won’t do as I’m not an employee of either, but I would think that it would be fairly unlikely as our contract is a physically delivered contract for LCFS and the LCFS on ICE is financially settled. So, by their nature, they’re not fungible making it an unlikely outcome.

CaliforniaCarbon.info: How do you see Nadal’s future around the LCFS market?

Nathan: Our expectation is that these LCFS markets will grow and as I mentioned there are other LCFS markets in development is US and Canada. And I think IncubEx and Nodal will attempt to provide instruments to help mitigate risk in those marketplaces as well, as they develop. To the extent that there are products related to LCFS and the renewable fuels space, that might be a logical steppingstone ahead.

CaliforniaCarbon.info: What are the other products that you intend to launch and what is the timeline for the same?

Nathan: We definitely plan to offer an Oregon LCFS contract and hope to launch that very soon. We don’t have a firm launch-date yet, but I would hope that we have that out in the early part of 2020. We would want to work with other programs as well who have developed LCFS in various parts of the Northeast or Midwest part of the US. And then, to the extent that there’s a logical connection with these markets and other renewable fuel markets, we would want to go in those directions as well.

CaliforniaCarbon.info: Any suggestions for participants about to trade on the market?

Nathan: Absolutely. For folks who are interested in the contracts, we’d be happy to set them up on the exchange and if they are interested in price and volume data from the exchange, we’d be happy to take any enquiries.