EU carbon market weekly update - 7 November 2016

Continuing nuclear power problems in France, a modest week of auctions, and cold weather add up to a bullish outlook for EU Allowance prices this week, says Louis Redshaw.

EUA Price Action

Volatility returned to the EUA market as prices climbed to a new six month high of €6.62. The weekly trading range hit 86c, a marked increase on last week's 33c range. The froth came out of the market on Friday as prices fell away from the highs, but the week still closed 8.8% higher at €6.43.

We highlighted in previous weekly updates the importance of both a close above €6.00 and the previous high at €6.14, as the former level had been tested multiple times. Following Monday's flat close, with prices having tried and failed to go lower, Tuesday closed at €6.04 and subsequent trading on Wednesday saw those gains extended. Initial resistance at the previous high (€6.14) was soon overcome and further gains came immediately afterwards.

Continued power supply disruption in France and colder weather, both current and in the forecasts (see below), was behind the price rises. However, large gains in long term power prices over the week were not enough to offset the rises in both carbon and coal prices that led the clean-dark spreads lower. Ordinarily, this would have been bearish for carbon but the French nuclear power outages and colder winter weather are combining to increase fossil-fuelled generation demand across Europe. Generation plants that would otherwise have been idled or used for peaking generation under normal nuclear power supply are supplying the missing MWhs and creating additional real demand for spot EUAs.

Carbon peaked on Thursday following news that EdF had been forced to postpone the restart of five reactors due to ongoing safety concerns. This added to the nervousness of the market and led to a further uptick in power prices. It remains impossible to say with any certainty when the outages will be resolved.

Price Impact

EUA prices remain closely allied to short-term fossil-fuel power demand and thus to short-term power prices.

Fundamentally,allownces were already in short supply going into the year-end due to back-loading, and longer term forecasts suggesting a colder-than-normal winter will keep carbon demand strong. Ongoing nuclear power plant issues, a low auction week and cold weather all add up to a bullish outlook for carbon.

Met Office forecasts below average temperatures in its November - January forecast

The UK's Met Office has warned of below average temperatures for the coming months. The outlook does not predict day-to-day weather changes, but highlights an increased chance we will see a cold start to winter. It highlights the chance of a La Niña event, the cold version of the recently experienced El Niño, and says a La Niña would be likely to reduce the Westerly winds hitting UK shores that carry mild air from the Atlantic. Cold winters in the UK tend to happen only every few years and most are not noted for persistently cold weather, according to the Met Office. A colder than average UK winter would also affect other neighbouring countries and would likely lead to further gains for carbon prices as power and gas demand would rise.

UK carbon tax may be scrapped

In his forthcoming 'Autumn statement' UK finance minister Philip Hammond is rumoured to be considering axing the UK power sector's carbon price floor tax. At £18 ($22) per tonne of carbon dioxide, it is designed to incentivise cleaner forms of generation (compliance with the EU Emissions Trading System is still required) and may have been used to prop up prices to justify recent deals to build nuclear power stations in the UK. It has the effect of reducing coal burn and the UK's greenhouse gas emissions, but at a high price for UK industry.

We think this has a material chance of happening, and if it does, it would slightly increase demand for EUAs. This is because scrapping the tax, that isn't currently required for the UK to meet its emissions reductions pledges, would be welcomed by UK industry, reeling from the aftershocks of the Brexit vote. It also sends a warning shot across the bows of trade negotiations with Europe. The UK has headroom in its emissions reduction target, so having UK industry pay to help the rest of Europe meet its overall reduction target doesn't make a lot of sense. No trade negotiations, including those with the EU, will have greenhouse gas reduction stipulations that are tougher than those the UK has already unilaterally adopted.

The week ahead

We see no reason for the carbon price to fall this week and expect consolidation and moves higher. Our outlook into the year-end is a grind higher as the market is fundamentally short through Q4 2016 and the nuclear power disruption has added to that shortage. The cushion provided by short-sellers, betting on lower prices when backloading ends, has evaporated and won't come back until the weather and nuclear uncertainties start to go away. In the short term, another week with four auctions rather than five and continued cold weather, especially in the first half of the week, combine to favour further upside. But it is unlikely we will see last week's large gains repeated, unless there is further nuclear power disruption in France which further threatens power supply through the winter. The US presidential election should not have a big impact on EUA prices, although volatility in wider markets might be felt in carbon.

Louis Redshaw is a founder of Redshaw Advisors