Market Developments
- The week closes down 72c at €4.95 following the UK referendum
- Gains on Monday wiped out in the run up to the referendum
- Carbon plummets to €4.69 first thing Friday morning
- UK vote to leave the EU gives EU ETS a headache, ENVI Rapporteur Ian Duncan tenders resignation.
- Clean dark spreads strengthen
Auction Overview
- 17.260Mt comes to market in another 5 auctions, slightly lower than 18.178Mt last week
- July brings a further ~70Mt to market following ~72Mt in June
- Volume falls to ~21.5Mt in August due to the European holiday season
- See auction table below for more details.
EUA Price Action
As expected EUA trading last week was muted and slightly bearish in the run up to the UK referendum, the surprise result caused a large sell-off and other EU ETS specific repercussions. Gains on Monday, fueled by hopes of a vote to remain in the EU, were cancelled out through the week by the weight of such a full auction calendar and Thursday’s close, before the referendum result was announced, was level with the previous Friday’s close. Following the vote to leave the EU, global equity markets went into freefall and carbon, whose absolute price level is not set by any fundamentals, was inevitably caught up in the rout, gapping lower on the open and falling to a low of €4.69 in the opening 5 minutes. This represented a fall of 17% and although prices did recover somewhat as bargain hunting shorts and utilities provided good support, we still closed with a 12% fall week-on-week. The UK and the rest of Europe now face a period of massive uncertainty as details and timelines of the Brexit are clarified, including whether or not the UK will continue to participate in the EU ETS long term. The immediate picture for carbon is actually one of little change with a Brexit estimated to take at least 2 years and the only moving parts being whether or not UK utilities continue to hedge long term and the prospect of reduced demand due to the macro economic decline the uncertainty will inevitably cause. The global meltdown actually led to a strengthening of the clean dark spreads as power falls were outweighed by carbon and coal drops on Friday but this was tempered by the EUR also struggling to hold its value against the USD. EUA traded volume was not especially exciting on Friday, it didn’t match the high of the year to date by some margin and was about as high as it got in the crazy days of January. The market was probably already short so it’s unlikely we see a repeat of January’s daily sell offs. We also resoundingly bounced off 4.69, i.e. clear of 2016’s low to date at €4.62. Price Impact: carbon’s dive reflects the wider markets concerns, the coming days and weeks are likely to be volatile. EUAs are cheap at these levels, the market is trading short, short term fundamentals are a mixed bag and more market turmoil can be expected but on balance, assuming UK utilities have already optimised their longer term EUA exposure and that there are no further large shocks to the system, we are cautious bulls (more detail below).
Brexit analysis:
We set out our pre-referendum thoughts in our blog here. Our additional thoughts since we wrote that are:
- Strengthening CDS will see European utilities accelerate their hedging programmes. Better profitability while uncertainty reigns will be too good a hedging opportunity for them to miss.
- Companies that have not yet bought for this year’s production to date and those that have borrowed from 2016’s allocation to meet 2015’s emissions demand have an unexpected gain from Friday’s price fall.
- The UK leaving the EU ETS seems even less likely in the immediate aftermath of the vote as there will be, for now, support for keeping as much of the EU relationship intact as possible. This means that UK utilities may not be in such a hurry to unwind EUA hedges that are more than 2 years out. The market did not set a new low for 2016 on Friday which supports the theory that UK utility selling is muted.
- UK industry that is long, caused by pre-existing generous free allocation, now face a quandary post 2018.
MEP Ian Duncan tenders his resignation following Brexit vote
The EU ETS reform rapporteur UK MEP Ian Duncan has tendered his resignation from the post in light of the UK vote to leave the EU. As the lead in reform negotiations he was playing a crucial role in shaping the Phase IV reform package. His departure will lead to a replacement who may seek to amend his recent Phase IV reform package proposal. As a voice for a stronger and more ambitious EU ETS, his resignation is a blow to those hoping to see a stronger scheme governing Europe’s emissions. However, the Phase IV reforms were not especially price sensitive so there is little to be concerned about in that regard.
The week ahead
Overall the short term picture is little changed as auction volumes enter their third straight week of 5 auctions per week. Next week sees a volume reduction as there is no Wednesday EUA auction however July brings more than 70Mt to market, comparable to June’s volumes. This is bearish at first sight but August auction volume is only 21Mt. Stronger clean dark spreads support the carbon market and some industrials are taking advantage of the price correction to catch up with hedging this year’s emissions to date but offsetting this is the risk UK utilities and very long industrials unload EUAs into the market (as explored in our blog). Volatility is the only certainty in the week ahead as carbon and wider markets digest the implications of a Brexit. Uncertainty over the EU ETS ambition going forward, calls for referendums in other European countries and wider market struggles could weigh heavily on carbon only in the fullness of time. With the implications of a Brexit currently a massive unknown it is reasonable that there is more of a ‘wait and see’ approach taken by many participants. However, when a market gaps lower on the open as it did on Friday, there isn’t a major disruption to supply and demand, the market is trading short and there isn’t much of a bearish follow-through it is hard to ignore the old trading adage: a gap is always closed.
