The coronavirus outbreak has clouded the short-term outlook for California Carbon Allowances, but the long-term outlook remains bullish, says Nicolas Girod*.
Front-month prices for California Carbon Allowances (CCAs) fell by $0.43 to $17.31 (2.42%) last week, while the December 2020 contract shed $0.47 to $17.70 (-2.59%). In CAD, the front-month price rose by CAD0.25 to CAD24.06 (+1.05%), while the Dec-20 contract increased by CAD0.21 to CAD24.60 (+0.86%) due to changes in the USD/CAD exchange rates. The volume of CCAs traded more than doubled from 25.621Mt to 55.586Mt and the total Open Interest increased by 9.2Mt to 250.2Mt.
Lawsuit ruling supports CCAs amid pandemic
On 11 March, the World Health Organization (WHO) declared the coronavirus outbreak a pandemic. Over the past week, the number of confirmed cases in the US increased more than ten-fold from 250 to over 2,700, with 370 cases in California. Despite the exponential increases in cases, public health experts expect that the severity of outbreak has yet to peak. After the WHO's pandemic announcement, Dec-20 CCA prices witnessed their largest daily losses since May 2019.
Despite the increasing bearishness from the virus outbreak, however, the market found some support due to the initial federal court ruling on the WCI linkage lawsuit released last Thursday. Judge William Shubb ruled that the cap-and-trade agreement between California and Quebec does not violate the US Constitution based on the Compact and Treaty Clauses. Although this is an early victory for California, the ruling will likely be appealed by the Department of Justice.
Our Forecast 
Last week's fall in CCA prices saw the largest weekly move in the front-month contract since last July. Dec-20 dropped even more, as the spread between the spot and December contracts narrowed further. The general macro-economic environment has become more bearish over the past week due to the coronavirus outbreak which has led to increased travel restrictions, business closures, and cancellations of major social events. As a result, the CCA market's sentiment is becoming increasingly impacted.
Last week's losses mean the front-month and December contracts are now both trading below next year's floor of $17.85 (assuming inflation of 2%). The position of financial participants continues to be a key factor, especially amid the ongoing outbreak and recent stock market crash. As of Tuesday 10 March, the net position of these participants was long 71.3Mt, after an increase of 368kt despite the weakening market sentiment. It is important to note that this position, however, does not consider the activity of these participants since the WHO's pandemic announcement last Wednesday.
With the general macro sentiment worsening, it is probable that, in the short term, these participants may limit their purchases in order to reassess their position and the possible impacts of the coronavirus outbreak. Our base-case scenario, however, still assumes that these new participants are in the market for the long-run, which will lead to their positions either remaining constant or increasing.
Overall, our view on prices remains bullish in the long run. However, over the short run, we have turned to a neutral outlook given the potential impacts to the market's fundamentals over the coming months. The recent coronovirus outbreak is the main bear flag to look out for in the coming weeks as the conditions have worsened and increasing safety measures are beginning to cause disruptions to economic activity. If the coronavirus outbreak conditions continue to worsen, this could significantly impact California and Quebec's emissions as fuel use is likely to decrease. In addition, nearly half of California is now facing moderate drought conditions. However, recent storms across the state are expected to provide some drought relief which will support hydroelectricity production this year, though, so far, although probably not enough to reach the historical highs of 2019.
* Nicolas Girod is managing director, markets, at ClearBlue Markets