Exploring the potential of the carbon credit program for hedging energy prices in Brazil

Abstract

The transition to a low-carbon economy is imperative to reduce reliance on fossil fuels and mitigate pollution emissions. This preposition also aligns with the United Nations Sustainable Development Goals (SDGs-13), which highlight the climate change action. In this vein, Brazil has implemented the Decarbonization Credit (CBIOS) program to incentivize biofuel production and promote environmental sustainability through carbon credit emissions. To this end, the present study evaluates the efectiveness of the CBIO contract as a hedging tool for investors in the face of energy price fuctuations and decarbonization eforts. Specifcally, we employ conditional dynamic correlation (DCC-GARCH) and optimal hedge ratio (HR) techniques to assess the relationship between CBIO and the futures and spot prices of sugar, oil, and ethanol. Our fndings suggest that the current CBIO contract is not an efective hedge against energy spot and future prices. However, our analysis identifes a strengthening correlation between ethanol traded in Chicago and CBIO over time, highlighting the potential for an underlying contract to serve as an efective hedging tool in the future. Our study adds to the existing literature on carbon pricing mechanisms and their impact on fnancial markets, emphasizing the importance of sustainable energy policies and their potential to mitigate the risks associated with energy price volatility and decarbonization eforts.