Market Developments
- WEBINAR: the impact of Brexit on the EU ETS with Energy Aspects’ Trevor Sikorski. Join us on 12th July, 2016 at 2:00 PM BST. Register here
- A further 32c wiped off the EUA price as week closes at €4.63
- Brexit appears to continue to put bearish pressure on the market
- However, clean dark spreads suffer large losses as power fails to keep up with coal price surge
- Netherlands rejects tiered leakage approach
- Sweden announces plan to buy and cancel EUAs following Vattenfall’s lignite sale
Auction Overview
- 14.454Mt comes to market in 5 auctions (13.770Mt EUAs & 0.6835Mt EUAA), down from 17.260Mt 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
The fallout from the UK referendum appeared to continue to apply bearish pressure on the carbon market last week as an additional 6% was wiped off the EUA price following last week’s 12% drop, however CDS levels were probably in the driving seat. It was one-way traffic for much of last week as carbon prices fell every day. Having been pushed through the €4.62 psychological barrier (February’s low) in aggressive selling early on Thursday when the market was thin, EUA prices fell to an intra-week low of €4.28 on Friday morning. However, they recovered into the close on Friday to finish the week at €4.63. Friday’s rally was triggered by power prices recovering sharply and was continued by the shorts that we expected to be present reducing or closing risk into the weekend as trading volumes were higher than average. They were wise to do so as on Saturday we received an announcement from the Swedish government that they would buy and cancel EUAs (see below). We said in our previous weekly update we were cautiously bullish however worsening clean dark spreads coupled with continued bearish news on European growth forecasts outweighed the bullish factors we identified. The road to a Brexit is getting longer and more uncertain by the day, Energy Aspects’ analysis of the situation is summarised below and we’ll explore this in more detail during our webinar next week (register here). Away from carbon, the clean dark spreads suffered heavy losses as the coal price rally continued unabated and power prices failed to keep up. The large CDS falls, particularly on the Calendar 18 and 19 contracts meant that utilities were largely on the sidelines in the EUA market last week, reducing demand from the biggest natural buyers in the market in a full auction week. Price Impact: with growth forecasts painting an ever bearish picture the selling pressure on carbon continues. The utilities hold the key to the market’s support levels and worsening clean dark spreads reduced their incentive to come to market and provide much needed support for EUA prices. At best UK utilities are adopting a ‘wait and see’ approach to their hedging following the referendum. This further dampens demand in the market. At worst they are unwinding the further out carbon positions for fear of getting left unhedged if the UK leaves the EU ETS as a result of a Brexit (see blog here). However, in opposition, we have low auction volumes this week and in August, noises from EU governments that they will buy and cancel EUAs and interest from short industrials to cover existing positions at an unexpected discount. Friday’s price action tells us the market was oversold and a bit short, we are moderately bullish subject to further bearish clean dark spread developments.
We will be analysing Brexit in more detail during our webinar with Energy Aspects’ Trevor Sikorski, to register your interest please click here.
Energy Aspects - Brexistential crisis
The Brexit vote ushers in a sustained period of uncertainty over the status of UK installations in the EU ETS. The uncertainty is extraordinarily significant across a range of levels. However, there are really two main outcomes possible—the UK retains a deep trading relationship with the EU and its installations stay in the EU ETS, or the UK has a shallower relationship of some sort and its installations leave the EU ETS.
If UK installations remain in the EU ETS, Energy Aspects expect little change to the outlook for market fundamentals, with the main adjustment being slightly lower regional GDP growth in the near-term, which would lead to a slight softening of emissions.
If UK installations leave the EU ETS, then the impact is significantly bearish for EUAs. Supplies could increase as long UK industrial installations push allowances into the market. If it becomes clear that they are leaving, then UK installations from all sectors will want to unwind any hedges that they have for future emissions, resulting in greater supply coming to the market than previously anticipated. We estimate that UK industrial installations will have a maximum 25-30 Mt to sell back into the market.
Under the case where UK installations leave the EU ETS, we see significant downward price pressure from the fundamentals from 2017 onwards. Therefore Energy Aspects now provide significantly different price forecasts, one with the UK in the EU ETS and one with the UK out of it.
The full report is available to our customers, please contact us if you are not already receiving Energy Aspects’ monthly carbon market research report.
Netherlands opposes tiered carbon leakage proposal
The Netherlands will oppose proposals to introduce a tiered carbon leakage list in Phase IV of the EU ETS. It favours a reduced carbon leakage list and more targeted allocation that would see only those on the leakage list receive free allowances. By reducing the sectors covered by the leakage list from 50 down to 5-8 the Netherlands believe it will allow for more frequent benchmarking calculations to be done to ensure the free allowances are targeted in the best way possible. In addition to the leakage list changes the Netherlands have called for a Linear Reduction Factor (LRF) of at least 2.2%, echoing calls by others to enable ambition to be increased, possibly mid phase, in light of the Paris agreement. Tiering was already gaining popularity in Brussels but this development is even more bad news for those not in the most leakage-exposed sectors as the NL proposal foresees ZERO allocation to everyone else from 2021. Every company needs to pay attention to the Phase IV proposals because there are increasing numbers of proposals that will result in a material free allocation reduction.
Sweden announces plans to buy and cancel EUAs
Sweden has announced a plan to buy and cancel EUAs up to a value of SEK 300 million on an annual basis. The amount of allowances this represents will change depending on the price of allowances and the exchange rate but at current prices it would remove around 6.5 Mt per year until 2040. On its own the move is unlikely to cause large upwards moves in the market, however, if more member states were to follow the lead of Sweden and announce similar plans it will have a material effect on the yearly demand and supply balance. Germany is known to be harbouring cancellation ambitions, in particular because its domestic target for CO2 emissions reduction is far tighter than its EU ETS target and they want the two policies to work more closely together. Expect more developments in the coming months.
The week ahead
The rally into the close on Friday will have made any remaining shorts take note as the tide may be turning for carbon prices. Having fallen to a new low on Friday morning it looked like a seventh straight day of price falls were in store however carbon found enough support to recover and make gains back to, and above, the psychological barrier of €4.62 (February’s low). A lower auction supply this week should help support prices but any potential gains will depend on how short the market is and whether the clean dark spreads can recover lost ground. A short squeeze will flush out the shorts and the market could likely rise quickly.
