In July, the drop in EUA prices to 4.5 €/t that we had expected simply did not occur. EUA prices consistently traded in a reasonably tight range between 5 €/t and 5.5 €/t, with a monthly average of 5.27 €/t.
We had expected July and August to be a real test of the emissions market given the y/y hike in auctions volumes—July primary auction volumes 26 Mt (40%) higher and August 32 Mt (233%) higher. Halfway that period through, however, the supply wave has not really weighed on prices.
Fundamentals provided some support, with French nuclear outages far higher than last July—averaging some 22 GW offline in July vs the July 2016 average of 12.5 GW offline. This heavier outage level would have added around 6 Mt to emissions via additional thermal generation.
Meanwhile, hydro was low in most markets. Spain and Italy are desperately low, while the French y/y gap deteriorated again in July, after briefly narrowing in June. Only the Nordics were up y/y, benefitting from a wet summer so far. This added around 2-3 Mt addition to emissions in July.
Industrial production continues its sustained run of good performance, with most of the energy-intensive sectors recording growth close to 4% y/y in May. But this is only likely to add some 8 Mt to emissions over the entire year, so a generous estimate for July would be an incremental 1 Mt.
Forward hedges were another source of added demand, with figures showing that the y/y gap in the level of open interest (OI) fell by some 15 Mt compared to last month. This suggests more hedging (or prop trading) was seen in the market y/y, helping to hoover up the high level of primary auction volumes.
Looking to August, the lack of any real bearish intent in July suggests that the market is reasonably well balanced. With some revisions to our forecast emissions, on low hydro and nuclear generation and higher industrial production, the 2017 annual supply demand balance shows no net change to market-held carbon inventory – down from an addition to net inventory. This suggests less downward price pressure than we previously expected on prices.
In this month’s Insight, we look at China’s energy policies to provide the context for understanding the potential impact of the national roll-out of emissions trading later this year. We find a policy environment in which the power sector is already being driven towards emissions reductions. The policy thrust is to build out renewables and, to a lesser extent, gas-fired plants. However, coal-fired generation could still increase in absolute terms to 2020.
For the Chinese emissions trading scheme (CETS) to have any impact on the operations of coal-fired power plants, China needs power sector liberalisation to introduce a more active spot power market. This will be required to introduce merit-order dispatch to China, and only then will adding compliance costs to coal-fired generators have any impact. The gas market will also need liberalisation, as the high gas prices currently seen at the city gate make it very difficult to displace coal with gas, given the coal prices that are likely to prevail. We will follow this analysis up with a more in-depth piece on China’s national ETS when the rules for that scheme are better defined.
The outlook for EUA prices for the rest of 2017 is a bit less bearish than last month, with our H2 17 prices now averaging 5 €/t, up from 4.5 €/t.