EU ETS Monthly Report — April 2019

European carbon advanced 20% in April, with the December 2019 futures contract ending the month at €26.29 on Ice Futures. Screen-traded volume in the benchmark cotnract was up almost 10% on March, as activity built up in the run-up to the annual compliance deadline.

The main price influence during the month was the postponement of the Brexit deadline from March 29 to October 31. The eight-month delay gives the UK Parliament another opportunity to ratify the withdrawal agreement reached with the European Union last year, though this postponement won’t allow for UK installations to resume participation in the market.

The text of the relevant Commission decision reads: “From 1 January 2019, the Central Administrator shall suspend the acceptance by the EUTL of relevant processes for the United Kingdom relating to free allocation, auctioning and the exchange of international credits.

“This suspension shall cease from the day following the one on which the instruments of ratification of both Parties to the Withdrawal Agreement are deposited… and the end of the suspension shall be made public.”

To this end, the EU ETS as a whole can be considered shorter on an annual basis, since UK installations routinely emit less than the country’s allocation of EUAs. This bullish factor generated a slight relief rally, with prices rising from €21.91 on April 1 to €26.13 just ten days later. Carbon reached a new 11-year high of €27.85 on April 12.

Participants said this Brexit- and compliance-related rally also encouraged speculative investors to resume building long positions, which some had been liquidating in March in expectation of a no-deal Brexit, which might have triggered widespread selling by UK installations.

Carbon was also supported by a gradual increase in natural gas prices: the June TTF contract rallied strongly by mid-month, gaining as much as 13%, while June coal fell 3%.

With gas-fired generation estimated to be preferred to all but the most efficient coal plants, carbon tracked the fortunes of power and gas over the course of the month. The 30-day correlation at the end of April between December 2019 carbon and calendar 2020 power was 0.949, while for calendar 2020 gas it was 0.863. Meanwhile, for carbon and coal the correlation was 0.502.

As the market moves into May, the end of compliance is expected to lead to a decline in demand, yet at the same time, the massive jump in carbon prices year-on-year (a year ago, the market ended April at €13.59) means many compliance installations will be managing their exposure more carefully by buying regularly.

In addition, utilities in southern and eastern Europe do not typically sell forward power and hedge fuels and carbon, and so are expected to continue to buy regularly to cover their ongoing generation.

The market was also tightened in April by interruptions in the auction schedule over the Easter break, and this will be repeated at both the start and the end of May. EU member states will sell 46.6 million EUAs in coming month, compared to 52.8 million in April.

Mid-May will also see the European Commission publlish its calculation of the Total Number of Allowances in Circulation (TNAC) for 2018. This number will be the basis for the operation of the Market Stability Reserve over the period from September 2019 to August 2020.

At present, the European Energy Exchange auction calendar for the period from September through to December lists a total of 305 million EUAs to be sold, but this total was only ever notional, and will be adjusted once the TNAC is known.

By the same token, several countries will shortly announce additional supply for auction from June, which will offset the reductions through the MSR to some small extent.

ALLCOT Group attended IETA EU Working Group Strategy Meeting in Brussels

Casiana Fometescu, who is in charge of Bussiness Development for Eastern Europe of ALLCOT Group, attended IETA EU Working Group Strategy Meeting, which took place in Brussels last week. The first presentation was from the representative of the European Commission, DG Climate action, Mrs. Beatriz Yordi, a very open message that the Commission is always open to listen, understand and act towards better climate and business conditions. She emphasized the idea of the stable framework of the EU ETS, the fact that CO2 is becoming one of the largest financial commodity where billions of euro are under trade and other coming funds are now expecting through the ETS Modernization fund.

She informed that revision of the auction regulation will start soon and IETA will be included in the consultations.

These are the ideas interesting to point out:

– Under the current new regulations of 2030 target of 40% GHG decrease, in reality a bigger decrease will happen of around 45%, taking into consideration current levels and also the linear reduction factor (LRF) of 2.2%;

– EU Emissions cap on 2030 will be around 1334 MtCO2 compared to the current 1,6 BtCO2. On 2050, the cap will be of just 370 Mt or only 14Mt (if LRF of 2.9% will apply);

– The analysts from Refinitiv pointed out that in the 2050 zero emissions concept target, the EU ETS CO2 price will either rise to 250-300 Euro/tonne or the EU ETS will no longer exist since its functionality might not have any sense;

– IETA pledged to lobby the European Commission to introduce an article in the EU ETS Directive regarding Article 6 from the Paris Agreement and international credits, to let these penetrate in the European market and to ask the EC if they agree with the Article 6 since this article is about linking international markets and accepting ITMOs into regional/national schemes. Thus, linking means the use of international credits into the EU compliance market;

– EUA prices will go up until 2022 or 2023 to reach then 30-35 Euro/EUA and then go down again due to the implementations of RES Directive and Energy Efficiency Directive, and from that date it’s expected to have again an excess of supply;

– Statkraft would like to propose to the EC an increase of MSR (Market Stability Reserve) to 24% and make the intake rate permanent;

– An interesting case was presented: Western Climate Initiative – the linkage scheme of California with Canada provinces Quebec and Ontario. Although, Ontario linked to the WCI on the 1st January 2018, they have already announced that they will exit the scheme this year due to technical and political reasons. Ontario estimate an increase in CO2 price till 40 Euro on 2030 from the current level of 16 Euro, which will destabilise its economy;

– Discussions on Brexit were also tabled, but the case seems too complicated even for UK nationals to foresee which scenario will be adopted, eventually. Yet, a hard Brexit will destabilise the EUA price compared to a Brexit with EU agreement. In the event of a hard Brexit, the idea of linking the future UK ETS with the EU ETS is an option.

– Switzerland approved to link its ETS with the EU ETS and implementation is expected to happen at the beginning of the next year.

EU ETS Monthly Report — March 2019

European carbon prices drifted 3.3% in March as utility demand faded amid poor generating margins for coal. The December 2019 futures contract ended the month at €21.54 after trading in a €3 range between €20.50 and €23.50.

Persistent weakness in natural gas prices meant that fuel-switching was the main market driver. Calendar 2020 TTF futures fell 8.7% in March, while API2 coal lost 10% and German power declined 5.5%.

The combination of price moves meant that gas-fired power remains more profitable than coal, with the result that demand for carbon allowances for future hedging was depressed. Utilities were notable for their modest participation in the market.

The onset of milder weather reduced heating demand, while a number of traders also highlighted weakening economic data that may signal a decline in industrial production.

Screen trading activity on ICE Futures declined, with 345 million EUAs changing hands in the benchmark EUA futures contract in March, compared with 415 million in February. However, there was a notable uptick in broker-arranged deals in the second half of the month, with so-called block trades on ICE reaching as much as 35 million EUAs on March 20, compared with the daily average of 8.6 million.

Participants were hard-pressed to explain the surge in block trades; with utilities largely on the sidelines, the most common explanation was investors shifting positions through time spreads.

The continuing uncertainty surrounding Britain’s withdrawal from the EU also contributed to depressed liquidity. British lawmakers twice rejected the negotiated withdrawal agreement, but also voted against leaving the Union without a deal. As of the end of March, the UK faces leaving the EU without a deal on April 14.

April kicks off with the release of verified emissions data for 2018, which analysts expect to reveal a drop of around 3-4%. The decrease is likely to reflect the onset of widespread fuel switching, as well as a strong recovery in hydro generation. Industrial production is expected to be broadly unchanged.

Towards mid-month the Brexit saga will reach another climax, with the current departure date scheduled for April 12. It’s not clear whether Parliament will manage to ratify the withdrawal agreement by then, and most observers are expecting the UK to seek a lengthy extension of the Article 50 deadline.

This may well mean that UK installations could continue to participate in the EU ETS through to the end of Phase 3 in 2020.

The impact on the market is likely to be bullish in the very short term, with traders driving a “relief rally”, but since the UK is generally accepted to emit less CO2 than it allocates in emissions allowances, prices may well decline in the longer term.

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

EU ETS Monthly Report – January 2019

The carbon market’s strong rally into the end of 2018 came to a sharp stop in January, as EUAs failed three times to breach the September high of €25.79. The December 2019 futures contract ended the month down almost 11% from the December 31 close at €23.30.

The extreme volatility of the fourth quarter, mainly the result of options hedging, gave way to a slightly calmer environment, though traders were quick to exploit opportunities to drive prices higher mid-month. The failure to top the existing  ten-year high then triggered selling as speculative traders liquidated positions.

The market was also characterised by a growing flow of bearish news and sentiment. The ongoing trade disputes between the US and various countries appears to be making itself felt in worsening economic prospects: US and German business confidence took a knock this month, while the US Federal Reserve displayed a new-found caution in its interest rates policy, preferring to hold rates stable and wait for further data.

Fundamentals in the carbon market also shifted this month. In 2018 coal-fired power was the more profitable choice in the benchmark German market, but as the new year started, natural gas prices have fallen back amid plentiful global LNG supply, and this has rendered gas-fired power competitive for calendar 2020 and 2021.

Coal prices, too, have not helped. API2 calendar 2019 coal prices rose into the $90s in October last year, but fell back to the low-mid $80s quickly after that, and there has been little reason for them to rise since.

As a result, utilities are reluctant to sell forward power from coal plants, and this has damped demand for EUAs. There may also be an element of reduced demand ever since RWE announced that it was financially covered for carbon until 2023: other utilities will no doubt have followed suit.

Weather has also been a factor in January. Temperatures have not dropped to significant below-average levels, and this has hurt demand for heating. The weather outlook for February is still fluid, but there remain chances of a prolonged cold snap, meteorologists say.

Supply in February will be boosted by the resumption of weekly German EUA auctions, which will increase total February availability to 51.6 million EUAs compared to 38.8 million in January.

Despite the additional auction supply, there are some participants who hold a slightly bullish outlook for the month, however. Analysts calculate the market balance as short by more than 10 million EUAs in February, which could boost prices. At the same time, compliance buyers will be on the look-out for opportunities to buy cheap carbon, and this may mitigate downward price potential.

EU ETS Monthly Report – December 2018

European carbon allowances ended December at €25.01, posting a 200% gain for the year. The much-anticipated expiry of the December 2018 options contract proved anti-climactic, and prices consolidated ahead of a widely-expected surge in January.

The market set numerous records in 2018, including a ten-year intraday high of €25.79 and the largest annual front-year screen traded volume on ICE Futures of more than 4 billion EUAs.

Carbon prices rose in 19 of the last 20 months, and analysts are generally bullish on the prospects for further increases in 2019.

The month of December saw EUA prices continue to recover from the collapse in October and November, rising 21% over the course of the month from €20.63 to €25.01.

Numerous traders began the month positioned for the expiry of the December 2018 options contract. Futures prices centered around the €20 mark for the first two weeks, reflecting the large open interest in options with a strike price at €20.

Once the options had expired, prices began to move upwards sharply and had risen back above €24 by the time the December futures expired on December 17.

Over the holiday period the December 2019 contract, which is now the benchmark for the market, consolidated at around €25 as trading activity fell away.

The outlook for January is generally seen as strong, as the Market Stability Reserve starts operation. The MSR will remove around 40% of all auction supply in 2019 as pat of a multi-year effort to remove the market’s approximately 1.6 billion EUA surplus.

However, additional upside risk has been added by a delay to German auctions, which are expected to resume later in the first quarter. At the same time, UK auctions have been suspended for the first quarter, as the UK government awaits Parliamentary approval of its withdrawal agreement.

Brexit will have a sharp but brief impact on the market, most sources agree. A failure by the UK parliament to ratify the withdrawal agreement may lead to a “no-deal” scenario in which the UK leaves the EU on March 29 without any transitional arrangements in place.

This may trigger a short-term surge of selling of surplus pre-2019 allowances by UK emitters, while others may also transfer allowances to affiliated companies on the continent.

However, if Parliament approves the Brexit deal, this would allow UK companies to continue participating in the EU ETS until the end of the current phase in 2020, and may lead to a slight drop in prices, since the UK is net long EUAs, most sources say.

Participants expect EUA prices to target the recent multi-year high at €25.79, before moving further ahead as the lack of new supply begins to bite.

Monthly EU ETS Report – October 2018

EUA prices snapped a 17-month winning streak in October, losing nearly 23% as the market tumbled from €21.21 on September 28 to close at €16.36 on October 31. In euro terms, it was the largest monthly drop in ten years.

On the way down the front-December contract set a new volume record on Ice Futures, with screen trades totaling 576 million EUAs, as traders scrambled to unwind profitable positions.

Most of the damage was done in the second half of the month, as the pace of profit-taking increased following the Carbon Forward conference in London. At the event, senior traders and analysts warned of increased volatility between now and the end of the year as speculators managed massive options exposure, a significant price drop in December, while price forecasts ranged between €25-40 in 2020, and €17-29 by 2030.

The market came away from the conference with the sense that the year’s bull-run was well and truly over, and this triggered a slump in prices starting from €19.27 on October 17 (the first day of the event), representing about two-thirds of the monthly loss.

Timespreads had also enjoyed a strong performance in the previous two months, with the December 2018-December 2019 spread wideing from €0.27 in mid-August to €0.98 two months later. This took the implied cost of carry well beyond the market norm, and traders increasingly sold the spread on the basis that they could finance the carry trade internally much more cheaply.

After mid-month, however, spreads began to shrink as outright prices retreated and buying interest at the wider differentials disappeared. This opened up a profitable buying opportunity for those traders who had shorted the spread, and by the end of October the December 2018/2019 differential was back below €0.30.

There were political headwinds too. The Polish government called for EU intervention in the market, saying that prices had reached a level where additional EUAs could be injected into the market. However, only Romania voiced any support, and as the month ended the “trigger” point for intervention seemed further away.

Continuing uncertainty over Brexit continued to underpin the market, with the UK government issuing an advisory note to business on what may happen in the event of a “no-deal” Brexit. Coupled with statements by the Energy & Climate Minister Claire Perry, there seems to be a growing sense that the UK’s long-term objective, “no-deal” Brexit or not, is to set up its own emissions trading system and link it to the EU’s market.

In the meantime, a no-deal outcome would see UK industry paying a new Carbon Emissions Tax of £16/tonne, while the present Carbon Price Support will continue at £18/tonne. Numerous observers pointed out that this may mean UK industry would get a “free pass” in the first quarter of 2019 if the UK crashes out of the EU with no deal, as the tax would only take effect from April 1 2019.

EU ETS Monthly Report – April 2018

European carbon completed twelve consecutive months of price increases in April, setting a new record for sustained gains, as the annual compliance cycle combined with continued speculative interest to boost the market.

December 2018 EUAs ended the month up by 2.3% from March 29 at €13.60/mt on ICE Futures; one year ago the contract closed at €4.57/mt!

April started with the publication of EU ETS verified data for 2017: CO2 emissions last year rose by around 0.3%, the first increase since 2010. An increase had been widely forecast, due mainly to increased coal generation as nuclear plants suffered reliability problems and hydro generation was very low in many parts of Europe.

The market managed to fend off repeated bouts of profit-taking and some attempts to squeeze long positions out of the market, and during the month EUAs set a new 6.5-year record price of €14.22/mt.

Trading volume in the front-December contract was down around 12% from March, as the rapid price rise (31%) of last month gave way to a relative consolidation in April.

Carbon has risen exactly two-thirds since the start of 2018, and if analyst forecasts are to be believed, we may see prices heading towards €15/mt later this year. With the Market Stability Reserve’s launch growing ever closer, more and more industrials are believed to be building reserves of EUAs while they remain relatively cheap.

The month’s price action was dominated by speculative traders and by the annual compliance cycle. Industrial installations and power stations had until April 30 to deposit with the European Commission EUAs matching their verified emissions for 2017.

According to market sources, many industrials had put off buying their remaining EUAs in the hope of achieving lower prices. There were numerous reports of last-minute buying in the final week which no doubt helped to boost prices.

While compliance was reaching its climax, the speculative element continued to support the market, betting on higher prices in the coming months. Open interest in call options for December 2018 EUAs has risen to 207 million tonnes, while put options show a total of 139 million tonnes of OI.

The majority of open interest in the call options rests between strike prices of €13-20, suggesting that if prices rise further, sellers of these options will need to buy additional EUAs to cover their exposure.

The question in the market is what will happen to prices now that compliance is over. Fundamentals do not support carbon at such high levels, many traders say. With the clean dark spread in negative territory for a significant number of coal-fired generators, the incentive to sell forward power and the hedge is limited.

Even margins for lignite-fired plants – typically among the cheapest but dirtiest to operate – are shrinking, analysts say.

There’s considerable speculation over just how much forward power utilities are selling at these profit margins. If power generators aren’t selling electricity and buying carbon, then who will keep the EUA price up above €13.00?

Trading in May will, therefore, be closely watched for any signs that speculative interest is diminishing. Analysts in mid-April raised their price forecasts for 2018 by around 30%, but it remains to be seen whether carbon can average around €12.00-13.00 for the whole year.