While EUAs drifted up gradually in August, the EU ETS became alarmingly unstable this month. Historic close-to-close 10-day volatility, which ran at 20-40% for most of the previous six months, has been in the 50-70% range in September. On three days this month the gap between the daily high and low was over 60 cents (around a 10% swing on the day).
The most unusual thing about this is that there is nothing close to a consensus view on what was driving this behaviour. While we readily concede that there are a range of explanations, the most disruptive event we saw this month came from MEPs, as the European Parliament inserted a ‘Brexit clause’ into legislation it passed that would remove international aviation from the ETS.
The Brexit clause would make void all EUAs issued by a country leaving the ETS issued from January 2018 onward that are still in circulation. The intention of the bill is to prevent UK installations from selling surplus back into the market in the event of UK installations leaving the ETS, but simple compliance and trading strategies suggest the bill will fail in achieving that goal.
However, if designated UK EUAs are created, the higher risk associated with those volumes should usher in a two-tier market with primary UK EUAs trading at a discount to non-UK EUAs. The size of the discount should be largest immediately after the annual compliance deadline, and should be the smallest as the market gets closer to the next compliance deadline (or contract delivery if participants will be able to deliver any compliant EUAs into the derivatives contracts).
This potential fracturing of liquidity was bullish for non-designated UK EUAs, which is all of the current market. One of the biggest daily price moves seen this month came on 14 September, when news of the Brexit clause became public. We feel that the most likely primary driver of September’s hyper volatility comes down to the Brexit clause, and one should never underestimate the ability of politicians to fundamentally disrupt this market.
This is not to dismiss the fundamental price support being offered elsewhere, particularly the ongoing tribulations at French nuclear plants. This month the French nuclear regulator, ASN, issued several orders to EDF regarding its nuclear fleet, with the upshot being that Q4 17 at least could see high levels of outages, similar those seen in Q4 16. Given that increase in scheduled outages for the next two months, plus revisions to estimates of Q3 17 generation emissions, we have hiked our forecast for power sector emissions in 2017 by around 3.0% on previous forecasts.
Higher power sector emissions, combined with some of the strongest industrial production growth numbers we have seen for years, has created some underlying higher demand for EUAs. With those drivers now likely to persist through Q4 17 and into Q1 18 (though it is less clear what the nuclear situation will be during that period), and given the coming winter is set to start off cooler than normal, calling a significant downward repricing in the next month or so seems brave. With two important carbon-related EU trialogue meetings scheduled for October, the appetite seems limited in the market for a swing back to big short positions.
Across all of Q4 17 we will see a limited price correction, with prices likely to be trading in the 6.5–7.5 €/t range. We forecast that prices in Q4 17 will average 6.75 €/t, a 1 €/t increase on last month’s forecast. We also forecast that prices will rise to average 7.8 €/t in 2018, up by 1.8 €/t from last month’s view, largely due to our forecast that of a higher base provided by expected end-2017 levels.