Leveraging Language Models for Carbon Market Insights: News Sentiment and Price Dynamics

Abstract The carbon credit system plays a pivotal role in offsetting emissions, mitigating climate change, and enabling trading opportunities. We examine California's Low Carbon Fuel Standard (LCFS) using time series data from 2013 to 2024 to analyze carbon credit price dynamics and improve predictive capability with machine learning and large language models (LLMs). Technical analysis is employed to capture short-term trends (using monthly LCFS transaction data). While effective in identifying general price trends, these models struggle to adapt to shifts caused by policy changes or supply-demand fluctuations and offer limited insight into market dynamics. To address this, we incorporate news articles covering general carbon market topics. LLMs are employed for sentiment analysis, generating sentiment scores ranging from -1 (extremely negative) to 1 (extremely positive) and categorizing influence into short-term, mid-term, or long-term. The aggregated sentiment scores achieve over 60% alignment with price change. We further enhance prediction performance by integrating news data directly with trading data into advanced LLMs, including Gemini 1.5 Pro, Claude 3.5 Sonnet, GPT-4o, and o1-preview, resulting in higher F1 scores and improved accuracy. These LLMs demonstrated the ability to synthesize diverse information and provided clear market insights. For long-term forecasting, we integrate news data and LCFS trading data with California’s gasoline and diesel prices, annual CO2 emissions, electric vehicle sales, Cap-and-Trade (CaT) carbon tax prices, EU Emissions Trading Scheme (ETS) carbon prices, and Canada’s federal fuel charge into LLMs. The long-term prediction achieves F1 score up to 0.8, capturing price transitions and providing reasoned insights. This study highlights the potential of LLMs in carbon market forecasting, especially in enhancing interpretability and decision-making.