Glossary

Arbitrage

A form of trading that takes advantage of varying prices for equivalent goods, usually in different markets. For example, an arbitrage trader may simultaneously buy wheat in Chicago and sell it in New York, profiting from the price differences at that moment. In principle, this type of trading is risk-free, although in practice traders use computer-based statistical modeling to analyze ‘arbitrage opportunities.’

In mainstream economic theory, arbitrage serves the purpose of correcting price imbalances. However, it is also used to manipulate prices. For example, when traders see potential differences between current (spot) and future prices for commodities like food and oil, they have been known to buy large them in large quantities and store them until the price rises. This was a key factor in the 2008 global food crisis.

In the case of carbon trading, arbitrage opportunities exist because EU emissions permits (EUAs) and UN offset credits (CERs or ERUs) are both treated as ‘one tonne of carbon’ but trade at different prices. Traders then seek to model these differences in relation to various other risks (e.g. that offsets won’t be delivered on time, or that certain types won’t be accepted as ‘one tonne’ in future).