EU carbon market update, 8 October 2018

Friday's strong close in the EU Allowance (EUA) market suggests further gains might be in store this week, says Louis Redshaw

EUA Price Action

EUA prices firmed last week, despite the inflated auction volumes on offer as strong buying support emerged. We went into the week with a bearish outlook based on higher auction supply, but three of the week's auctions cleared at or above the prevailing secondary market price, a clear indication of strong demand.

Much of the week was spent trading around €21 as bulls and bears fought for supremacy. Moves below €21 found buyers as the €20.70 level highlighted by technical analysts FuturesTechs held. Intra-day moves below this level found support strong enough to repel the attack and propel prices back above it by the end of each day. Despite this, it took until Friday for the bulls to get on top as a strong (despite being larger than usual) German auction started a move higher that continued for the rest of the day.

The daily trading range was around €1.00 indicating that the EUA market has calmed down after the previous weeks' frenzied trading. Last week's full trading range was around €1.70, lower than recent weeks, but still above the average for the year (€1.05) to mid-August. The price gains were aided by a strong energy complex as power, coal and gas prices all rose over the week. The impact on the clean-dark spreads was mixed as the front two years improved whilst the Calendar 2021 and 2022 spreads fell.

Price Impact: The gains despite the higher auction volume shows that demand remains robust. The close at the highs on Friday and the slight dip in week-on-week auction volumes in the coming week suggest further gains might be in store...

Week ahead

Last week we said the auction supply was expected to be 24.1Mt, however, the figure was actually slightly lower as the UK auction featured fewer allowances than we expected, so the total supply last week was in fact 23.8Mt. This week the Polish auction replaces the UK auction so total auction supply is 21.6Mt across five auctions. Last week's strong auction results and a week of gains when we expected the opposite due to plentiful supply suggest that, provided demand is unchanged, EUA prices will continue to increase.

Technical analysis supports further gains with €22.78 the first major resistance but with an upside target of €25.79. On the downside, the first major support is at €20.96.

Over the coming two months there is nothing obvious that we know now that could cause carbon to head lower. Lower auction volume, technical analysis, the strong trend and rising prices in the energy complex all continue to support further gains. Of course, any downside in the energy complex, that carbon is likely to follow in the absence of carbon-specific drivers, could lead to some weakness as well as opportunistic industrial selling, but at the moment the outlook there is positive too. At best (from the point of view of short industrials) the week looks supported, at worst further gains appear the most probable outcome. Therefore, we go into the week with a bullish outlook.

EUA traded volumes continue to increase

Traded volumes of the EUA benchmark contract averaged 26.7 million a day in September, comfortably exceeding the previous high from available ICE data of 20 million a day in January 2016. On 13 September, the day after EUAs hit a ten-year high, 52.4 million EUAs were traded as shorts panicked and sellers took advantage of the high prices producing the second largest day-on-day decline (€4.00) since the EUA market launched.

Such volatility is symptomatic of the involvement of speculators in the market. The higher levels of activity contrast with weaker (except for last week) EUA buying interest in auctions, with two auctions of country-specific EUAs, one for the UK and another for Germany, being cancelled due to insufficient demand the week before last. In 2017, traded volumes dipped during October before rising again in November and December, presumably due to year-end accounting. However, current October levels suggest trading activity will remain higher this month.

Net-zero emissions by 2050 is a possible outcome of EC's long-term strategy

A report, prepared by climate and energy consultancy Climact and think-tank the European Climate Foundation, said that wind and solar power generation should make up at least 50% of power output by 2030, rising to 60% if a 2050 net-zero target is to be technically and economically feasible.

The report also highlights the need for the increased adoption of demand-side management across the European power sector over the coming years, as well as the need for transport emissions to be cut through a modal shift away from conventionally-fuelled vehicles. The EU's current long-term climate target is for an 80% cut in emissions by 2050 from 1990 levels. The European Commission is due to publish its long-term climate strategy in November, with one of the scenarios under consideration being a pledge to reach net-zero emissions by 2050.

UK coal generation rises in September

UK coal-fired power generation rose in September, reversing the trend of year-on-year declines. Average coal burn last month was slightly above 1.7GW, up from 1.4GW in September 2017. The resurgence of coal was driven by wider clean-dark spreads that increased coal plant profitability despite a 300% increase in the price of EUAs. This has been caused by the price of the UK’s NBP gas contracts being driven higher this year, the September NBP gas contract expired at 68.48 pence per therm, compared with 45.20 pence for September 2017. With European gas stocks still in need of injections going into winter, operators can’t burn additional gas for power without causing NBP and Dutch TTF prices to rise. This prevents coal-to-gas fuel switching on the continent and is one of the causes of the meteoric EUA price rise.

Louis Redshaw is a founder of Redshaw Advisors