EU carbon market update, 12 November 2018

Price Action

We went into the week with a neutral outlook but warning of upside potential. That potential was realised as prices surged more than €2 to end the week at €19.46, up more than 14%.

Our outlook, set just after the start of the most recent upturn in price, was rather cautious due to carbon not continuing to drop despite severe hurdles that should have held the price at bay, mixed auction demand data, mild weather and the recent weakness in carbon and wider energy prices, particularly gas.

The previous week's gains were extended in the first half of the week. However, progress was slow and not entirely convincing as carbon came under some pressure from the sell-side. Monday posted the low of the week at €16.37, following a weak auction.

Despite this inauspicious start, carbon managed to finish the day in positive territory, a feat it just managed to repeat on Tuesday as the support on the down move became insurmountable resistance at €17.60-€17.90. However, the resistance was broken on Wednesday, precipitating further rabid buying and causing prices to surge more than a euro higher. This was followed up by another 90 cents increase on Thursday.

The surge in carbon prices last week coincided with gas prices turning a corner and even gapping higher. This, and simultaneous power price rises, fed carbon demand and provides an explanation for the suddenness and magnitude of EUA price rises such that €20 was back in sight (the high of the week was set on Friday at €19.92).

Price Impact: resurgent power and gas markets led the way last week and fears of a carbon price meltdown ahead of option expiry were emphatically dispelled....

Week Ahead

The week ahead is the last in 2018 with a full auction schedule. The hastily arranged Latvian auction that replaces one of the German auctions seems to be the only one we can expect this year. German auctions have been cancelled until further notice, and are currently expected to return some time towards the end of Q1 but that might happen faster if prices keep going higher. Come mid-December the auctions cease entirely for the Christmas break.

This week temperatures remain mild for the time of year. However, weather forecasts for next week and beyond suggest a return to normal temperatures. With the European gas market expected to be tight throughout this winter, gas price spikes are a real threat and will put additional upwards pressure on carbon.

Recent price action suggests there is plenty of dip buying waiting in the wings as carbon was able to bottom out and find upward traction after the other markets started to fall and before the other markets recovered. With an unprecedented interest in the EUA market ahead of the Market Stability Reserve (MSR) the declines were a test of the resolve of those with long-term long positions. The fact carbon avoided a price meltdown suggests those that still own carbon are targeting longer timeframes and materially higher prices before liquidating their positions. This behaviour is important as it reduces the chance of a complete position washout when the unprecedented levels of option open interest expire in December.

Overall, we go into the week with a bullish outlook. However, with so many price drivers colliding in the coming five weeks the market will remain volatile and moves in either direction remain possible. December will see the much discussed options expiry, the last of the 2018 auctions and the 2018 futures expiry all within the space of a week.

Other News

€17 carbon prices are "acceptable" according to Poland's energy minister - Carbon Pulse

During September Poland asked the EU to intervene in the EU ETS after prices went over €25. However, recent comments by the country's energy minister suggest recent declines have softened their desire for intervention. According to Carbon Pulse, the minister said prices of €17 are "acceptable".

Most of Poland's power comes from burning coal (hard coal and lignite), meaning soaring coal and carbon prices are hurting industry and consumers. The Polish government is preparing a plan to compensate industry and consumers for rising carbon prices using proceeds from its EUA auctions. Romania is also urging an investigation into possible market manipulation, claiming that Greece and Spain also back the move. Despite this, EU officials have said the price rise is positive.

Carbon offset allowances remain in demand

Data published by the European Commission last week indicates 51Mt CERs have been exchanged for EUAs since 2018 began, including 2.1Mt since May 2018. This brings the overall number of offsets exchanged to over 436Mt in Phase III. With EUA prices having, at their peak, trebled in 2018, the significant savings on offer for those with remaining CER exchange opportunities has spurred additional demand for the 'CER swap' as installations seek to minimise their EU ETS compliance costs.

The CER swap will be outlawed after 2020 so the opportunity is time limited for those with remaining eligibility. While some observers believe that there is a chance that the position will change next decade once the Paris Agreement's carbon trading rulebook is agreed and a successor scheme to the CDM is designed and implemented, it is unlikely. The use of 1.4 billion CERs in the EU ETS is the primary driver of the EUA excess that has dogged the market and kept it at single digit levels for the last eight years. The EU is unlikely to let a large quantity of offsets back into the system until other countries have similarly strict ETSs in place.

Louis Redshaw is a founder of Redshaw Advisors