European carbon prices drifted 3.3% in March as utility demand faded amid poor generating margins for coal. The December 2019 futures contract ended the month at €21.54 after trading in a €3 range between €20.50 and €23.50.
Persistent weakness in natural gas prices meant that fuel-switching was the main market driver. Calendar 2020 TTF futures fell 8.7% in March, while API2 coal lost 10% and German power declined 5.5%.
The combination of price moves meant that gas-fired power remains more profitable than coal, with the result that demand for carbon allowances for future hedging was depressed. Utilities were notable for their modest participation in the market.
The onset of milder weather reduced heating demand, while a number of traders also highlighted weakening economic data that may signal a decline in industrial production.
Screen trading activity on ICE Futures declined, with 345 million EUAs changing hands in the benchmark EUA futures contract in March, compared with 415 million in February. However, there was a notable uptick in broker-arranged deals in the second half of the month, with so-called block trades on ICE reaching as much as 35 million EUAs on March 20, compared with the daily average of 8.6 million.
Participants were hard-pressed to explain the surge in block trades; with utilities largely on the sidelines, the most common explanation was investors shifting positions through time spreads.
The continuing uncertainty surrounding Britain’s withdrawal from the EU also contributed to depressed liquidity. British lawmakers twice rejected the negotiated withdrawal agreement, but also voted against leaving the Union without a deal. As of the end of March, the UK faces leaving the EU without a deal on April 14.
April kicks off with the release of verified emissions data for 2018, which analysts expect to reveal a drop of around 3-4%. The decrease is likely to reflect the onset of widespread fuel switching, as well as a strong recovery in hydro generation. Industrial production is expected to be broadly unchanged.
Towards mid-month the Brexit saga will reach another climax, with the current departure date scheduled for April 12. It’s not clear whether Parliament will manage to ratify the withdrawal agreement by then, and most observers are expecting the UK to seek a lengthy extension of the Article 50 deadline.
This may well mean that UK installations could continue to participate in the EU ETS through to the end of Phase 3 in 2020.
The impact on the market is likely to be bullish in the very short term, with traders driving a “relief rally”, but since the UK is generally accepted to emit less CO2 than it allocates in emissions allowances, prices may well decline in the longer term.
Carbon prices staged a rally late in the month to end February down by just 1.4% at €21.69. EUAs had fallen by as much as 17% at one point during the month as speculative traders unloaded long positions and short-term power plant economics leaned towards natural gas.
Prices have declined by more than 13% since the start of the year as shifting spark and dark spreads have kept utility buying to the sidelines, and the uncertainty of Brexit has held the threat of a UK-based sell-off over the market.
The UK is now entering the final four weeks before Brexit Day, and there is little clarity over whether the country will quit the EU with a negotiated withdrawal agreement — that would keep UK installations in the EU ETS until the end of Phase 3 — and a no-deal scenario, which would see UK installations fall out of the market on March 28.
In the final week of February, UK Prime Minister Theresa May caved in to pressure from lawmakers and confirmed that Parliament will vote in mid-March on whether or not to delay Brexit.
At the same time, energy minister Claire Perry confirmed this week that the UK’s “preferred option” for the post-EU age is to have a stand-alone UK ETS, linked to the EU market. This option is seen as the most likely outcome whether or not the UK leaves the EU under a negotiated settlement.
The energy minister said the government will issue a consultation document on a future UK ETS at the end of April.
Beyond Brexit, the relative profitability of coal and gas-fired power continued to move in favour of natural gas over the course of the month. RWE confirmed it was bringing a number of gas-fired plants out of mothballs this year, suggesting the company had managed to lock in an acceptable margin for the period until 2021.
Market analysts concurred that the clean spark spread is in the money for the front-month and quarter, while coal is competitive on a year-ahead basis.
The outcome is that utility demand for carbon from utilities has been depressed this month, leaving the market vulnerable to volatility generated by speculative traders and options hedging in particular.
Some participants have called the underlying market somewhat thin this month, even though average daily screen volume has been more than 20 million EUAs a day, the most since October, and the third-most since the start of 2018. Options hedging tends to exaggerate price movements and inflate trading volume, so the likely inference is that utilities are very comfortably covered at the moment.
The outlook for March is dominated by issuance of 2019 EUAs, annual compliance and Brexit. UK installations have until March 15 to surrender EUAs matching their 2018 emissions, while the rest of Europe works to a March 31 deadline.
Since the UK is not issuing or auctioning any 2019 EUAs “until further notice”, UK installations may not borrow from future allocation for compliance, There are reports that some UK installations have been caught out by this, but this is not likely to be a major market factor.
Issuance of 2019 EUAs has already begun, and the process should be largely completed by the end of March. The injection of fresh supply may depress prices slightly as industrials decide to borrow for 2018 compliance rather than pay prices on excess of €20, but this is a risky strategy.
Finally, decisions on Brexit may generate some short term volatility as the end of March approaches. A no-deal Brexit risks seeing a surge of selling of surplus EUAs, while a vote in favour of the withdrawal agreement may be met with a relief rally
The carbon market’s strong rally into the end of 2018 came to a sharp stop in January, as EUAs failed three times to breach the September high of €25.79. The December 2019 futures contract ended the month down almost 11% from the December 31 close at €23.30.
The extreme volatility of the fourth quarter, mainly the result of options hedging, gave way to a slightly calmer environment, though traders were quick to exploit opportunities to drive prices higher mid-month. The failure to top the existing ten-year high then triggered selling as speculative traders liquidated positions.
The market was also characterised by a growing flow of bearish news and sentiment. The ongoing trade disputes between the US and various countries appears to be making itself felt in worsening economic prospects: US and German business confidence took a knock this month, while the US Federal Reserve displayed a new-found caution in its interest rates policy, preferring to hold rates stable and wait for further data.
Fundamentals in the carbon market also shifted this month. In 2018 coal-fired power was the more profitable choice in the benchmark German market, but as the new year started, natural gas prices have fallen back amid plentiful global LNG supply, and this has rendered gas-fired power competitive for calendar 2020 and 2021.
Coal prices, too, have not helped. API2 calendar 2019 coal prices rose into the $90s in October last year, but fell back to the low-mid $80s quickly after that, and there has been little reason for them to rise since.
As a result, utilities are reluctant to sell forward power from coal plants, and this has damped demand for EUAs. There may also be an element of reduced demand ever since RWE announced that it was financially covered for carbon until 2023: other utilities will no doubt have followed suit.
Weather has also been a factor in January. Temperatures have not dropped to significant below-average levels, and this has hurt demand for heating. The weather outlook for February is still fluid, but there remain chances of a prolonged cold snap, meteorologists say.
Supply in February will be boosted by the resumption of weekly German EUA auctions, which will increase total February availability to 51.6 million EUAs compared to 38.8 million in January.
Despite the additional auction supply, there are some participants who hold a slightly bullish outlook for the month, however. Analysts calculate the market balance as short by more than 10 million EUAs in February, which could boost prices. At the same time, compliance buyers will be on the look-out for opportunities to buy cheap carbon, and this may mitigate downward price potential.
European carbon completed twelve consecutive months of price increases in April, setting a new record for sustained gains, as the annual compliance cycle combined with continued speculative interest to boost the market.
December 2018 EUAs ended the month up by 2.3% from March 29 at €13.60/mt on ICE Futures; one year ago the contract closed at €4.57/mt!
April started with the publication of EU ETS verified data for 2017: CO2 emissions last year rose by around 0.3%, the first increase since 2010. An increase had been widely forecast, due mainly to increased coal generation as nuclear plants suffered reliability problems and hydro generation was very low in many parts of Europe.
The market managed to fend off repeated bouts of profit-taking and some attempts to squeeze long positions out of the market, and during the month EUAs set a new 6.5-year record price of €14.22/mt.
Trading volume in the front-December contract was down around 12% from March, as the rapid price rise (31%) of last month gave way to a relative consolidation in April.
Carbon has risen exactly two-thirds since the start of 2018, and if analyst forecasts are to be believed, we may see prices heading towards €15/mt later this year. With the Market Stability Reserve’s launch growing ever closer, more and more industrials are believed to be building reserves of EUAs while they remain relatively cheap.
The month’s price action was dominated by speculative traders and by the annual compliance cycle. Industrial installations and power stations had until April 30 to deposit with the European Commission EUAs matching their verified emissions for 2017.
According to market sources, many industrials had put off buying their remaining EUAs in the hope of achieving lower prices. There were numerous reports of last-minute buying in the final week which no doubt helped to boost prices.
While compliance was reaching its climax, the speculative element continued to support the market, betting on higher prices in the coming months. Open interest in call options for December 2018 EUAs has risen to 207 million tonnes, while put options show a total of 139 million tonnes of OI.
The majority of open interest in the call options rests between strike prices of €13-20, suggesting that if prices rise further, sellers of these options will need to buy additional EUAs to cover their exposure.
The question in the market is what will happen to prices now that compliance is over. Fundamentals do not support carbon at such high levels, many traders say. With the clean dark spread in negative territory for a significant number of coal-fired generators, the incentive to sell forward power and the hedge is limited.
Even margins for lignite-fired plants – typically among the cheapest but dirtiest to operate – are shrinking, analysts say.
There’s considerable speculation over just how much forward power utilities are selling at these profit margins. If power generators aren’t selling electricity and buying carbon, then who will keep the EUA price up above €13.00?
Trading in May will, therefore, be closely watched for any signs that speculative interest is diminishing. Analysts in mid-April raised their price forecasts for 2018 by around 30%, but it remains to be seen whether carbon can average around €12.00-13.00 for the whole year.