Emissions traders can be broken down into two main categories: hedgers and speculators.
The price of emissions is influenced by many factors such as the growth of polluting industries, faster economic development in countries like China (the world’s largest polluter), stricter regulations, narrower cap on pollutants, etc. In order to reduce the impact of these price fluctuations on firms that use emissions permits to offset their pollution, emissions futures were introduced. Emissions futures offer these market participants a way to hedge their risk and manage the cost of their emissions.
Firms that are looking to sell excess emissions permits can minimize the risk of price fluctuations in the emissions market by using a short hedge. This will lock in a fixed selling price for the emissions, so that these firms will get the specified amount in the contract, even if prices fall in the future. Growing businesses that need emissions permits can use a long hedge to set a fixed purchase price for a specified quantity of emissions permits as per their need.
Emissions futures are also traded by speculators. Speculators have no vested interest in the underlying asset, that is, they will neither deliver emissions permits nor take delivery for emissions permits. They trade in and out of emissions futures only based on speculations about the price fluctuations of emissions over the trading period. They take on the price risk that hedgers are trying to avoid, because they hope to profit from price movements in the emissions market.