EU ETS Monthly Report — February 2019

Carbon prices staged a rally late in the month to end February down by just 1.4% at €21.69. EUAs had fallen by as much as 17% at one point during the month as speculative traders unloaded long positions and short-term power plant economics leaned towards natural gas.

Prices have declined by more than 13% since the start of the year as shifting spark and dark spreads have kept utility buying to the sidelines, and the uncertainty of Brexit has held the threat of a UK-based sell-off over the market.

The UK is now entering the final four weeks before Brexit Day, and there is little clarity over whether the country will quit the EU with a negotiated withdrawal agreement — that would keep UK installations in the EU ETS until the end of Phase 3 — and a no-deal scenario, which would see UK installations fall out of the market on March 28.

In the final week of February, UK Prime Minister Theresa May caved in to pressure from lawmakers and confirmed that Parliament will vote in mid-March on whether or not to delay Brexit.

At the same time, energy minister Claire Perry confirmed this week that the UK’s “preferred option” for the post-EU age is to have a stand-alone UK ETS, linked to the EU market. This option is seen as the most likely outcome whether or not the UK leaves the EU under a negotiated settlement.

The energy minister said the government will issue a consultation document on a future UK ETS at the end of April.

Beyond Brexit, the relative profitability of coal and gas-fired power continued to move in favour of natural gas over the course of the month. RWE confirmed it was bringing a number of gas-fired plants out of mothballs this year, suggesting the company had managed to lock in an acceptable margin for the period until 2021.

Market analysts concurred that the clean spark spread is in the money for the front-month and quarter, while coal is competitive on a year-ahead basis.

The outcome is that utility demand for carbon from utilities has been depressed this month, leaving the market vulnerable to volatility generated by speculative traders and options hedging in particular.

Some participants have called the underlying market somewhat thin this month, even though average daily screen volume has been more than 20 million EUAs a day, the most since October, and the third-most since the start of 2018. Options hedging tends to exaggerate price movements and inflate trading volume, so the likely inference is that utilities are very comfortably covered at the moment.

The outlook for March is dominated by issuance of 2019 EUAs, annual compliance and Brexit. UK installations have until March 15 to surrender EUAs matching their 2018 emissions, while the rest of Europe works to a March 31 deadline.

Since the UK is not issuing or auctioning any 2019 EUAs “until further notice”, UK installations may not borrow from future allocation for compliance, There are reports that some UK installations have been caught out by this, but this is not likely to be a  major market factor.

Issuance of 2019 EUAs has already begun, and the process should be largely completed by the end of March. The injection of fresh supply may depress prices slightly as industrials decide to borrow for 2018 compliance rather than pay prices on excess of €20, but this is a risky strategy.

Finally, decisions on Brexit may generate some short term volatility as the end of March approaches. A no-deal Brexit risks seeing a surge of selling of surplus EUAs, while a vote in favour of the withdrawal agreement may be met with a relief rally

ALLCOT

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