21 January 2019
- Carbon ends the week 9% higher at €24.86
- Technical support at €21.80 once again holds firm
- Cold weather, climbing energy prices and low auction supply provide launchpad for moves higher
- Germany close to agreeing coal phase out
- Brexit vote provides no further clarity on EU ETS inclusion for UK installations
- European carbon trading volumes surge in 2018
EU ALLOWANCE AUCTION OVERVIEW
- Auction volumes falls to 7.5Mt, down from more than 11Mt last week, and 9.5Mt lower than the corresponding week in 2018.
- No UK auctions in Q1 due to Brexit
Carbon ended the week at €24.86, a gain of €2.14 (9%) as short-term fundamentals took over. The main moves higher came on Wednesday and Friday as the chances of a hard-Brexit appeared more remote and the cold weather took a hold. We had maintained our bullish outlook on prices going into the week, however, Monday saw another test of the downside support. Carbon was facing intraday losses of nearly a Euro, but technical support identified at €21.80 held firm by the close of play, having been breached momentarily (again) as prices hit the low of the week at €21.78.
The hold of the technical level gave the bulls fresh impetus, but Tuesday was all about the Brexit vote. Trading was muted amid low volumes and a tight trading range as traders went into Tuesday evening's Brexit vote with a risk-off approach. The Brexit agreement was rejected by Parliament, ensuring Brexit uncertainty will last a while longer.
Despite this, the shackles came off the carbon price on Wednesday as more than 78c was added to the price. The gains were driven by a combination of pent-up buying by traders who waited on the outcome of the vote, speculators closing or reversing short positions once it became clear there would be no Brexit-related downside (the GBP/EUR FX rate did something similar and the pound strengthened) and surging power and prompt gas prices as a result of cold weather forecasts and low renewable output.
There were further modest gains on Thursday before the biggest move of the week on Friday. Prices soared more than a euro as the combination of colder weather supporting the energy complex and no auctions meant there was little resistance standing in the path of moves higher.
Price Impact: the (eventual) downside rejection was emphatic as the short-term fundamentals came to the fore. Just three auctions in the coming week reduce total auction supply further to less than 7.5Mt.
There is a chance of further Brexit-related turmoil this week as PM Theresa May presents her 'Plan B' for Brexit. At this point all options remain on the table. Other than a hard Brexit, we are neutral-bullish for all other outcomes.
Auction supply falls this week to just 7.5Mt as the UK and German auction slots remain vacant. Whilst the longer-term generation spreads are not favourable, the cold weather and resulting increase in power demand and fossil fuel generation will ensure there is still healthy demand from the utilities.
Technical analysis suggests the next big hurdle for carbon is the €25.73-€26.00 level, which was the high of 2018. This is expected to be a big level, with carbon having fallen at this hurdle twice in the last four months of 2018.
However, should carbon manage to break this level, third time lucky perhaps, the next big target will be €29.69. On the downside, €22.87-89, €22.30 and €21.80 are the levels to watch out for.
Based on the cold weather and low auction supply it is hard not to go into the week with a bullish outlook. However, the weak Clean-Dark Spreads will limit utility demand for longer dated hedging and will likely temper gains. Given that some speculators will have positioned themselves for a rally and may now reverse those positions amid a weakening gas market, there is a chance of softness. However, overall we maintain our view that the short-term fundamentals will keep carbon supported at best and at worst lead to further gains.
Germany close to agreeing coal phase out
The German government has pledged long-term payments to lignite mining regions to help them with planned closures and the governing coalition has so far agreed to spend €1.5bn to help regions affected by the planned coal exit. However, North Rhine-Westphalia is looking for €10bn in support.
Chancellor Angela Merkel and Finance Minister Olaf Scholz said last week a deal from the coal exit commission is due by 1 February although key issues including supply security and power prices must be resolved first. It is thought that the German economy as a whole will barely suffer from phasing out lignite. However, the coal regions would see rising unemployment and people moving away unless the state aid is secured.
Unless the German Government cancels EUAs, as they have previously said they would, the price of EUAs will be depressed by significantly lower demand from lignite plants if the closures go ahead.
No further clarity on EU ETS inclusion for UK installations
The UK's continued involvement in the EU emissions trading system after March 2019 remains unclear following the UK Parliament rejecting Theresa May's draft withdrawal agreement for the country's exit from the EU last week.
The prime minister is expected to put forward a new Brexit plan this week. If the UK leaves the EU with a deal in place, it expected the country would continue to participate in the EU ETS until the end of 2020.
A no-deal Brexit would see the UK leave the carbon market on the country's scheduled EU exit date of 29 March. If the UK was to delay EU exit to after 29 March, we would expect to see a decision on the UK's ETS participation postponed beyond this date and an extension of the suspension of UK EUA auctions. It is expected a no-deal Brexit would be temporarily bearish for the allowance market, as UK emitters quickly sell off excess EUAs.
A deal would be neutral to bullish (it doesn't change what we already know about UK auctions but it will bring UK installations back to the market) and an Article 50 extension that is less than a year long would be very bullish (we think that the UK would have to keep its auctions on hold).
European carbon trading takes off once again
Global traded carbon volumes, dominated by Europe, rose 45% in 2018 to a five-year high of 9.1 billion tonnes as the EU ETS market saw significant price and participant gains.
This led to the overall value of global carbon markets reaching a record €144 bln, 90% of which resided in Europe. The previous high was in 2010 with a peak of €92bln. The majority of the price and volume rise has been put down to the introduction of the Market Stability Reserve in January 19 which will reduce 2019 auction volumes by up to 40%.
UN-guaranteed CER volume fell by around 30% due to falling opportunities for the exchange of these units in the EU ETS. In a recent survey the majority of the respondents supported carbon taxes, where revenues are given back to people or spent on climate projects. Some form of carbon pricing is seen as the most economically efficient way of reducing emissions worldwide, and while a global top-down system has failed to gain traction, the mechanism's use has tripled over the past decad
Louis Redshaw is a founder of Redshaw Advisors