European carbon

Published at 11:37 12 Feb 2018 by

Another week, another bounce on EUAs. The Dec-18 contract closed Friday up by 3% w/w at 9.23 €/t. The strength in the contract was reflective of the rapid downward pricing seen in European coal prices. M+1 Cif ARA dropped by 8.2% to 80.1 $/t in the last two weeks and global coal prices are now looking somewhat imbalanced, as the spread between Cif ARA and Pacific basin coal has widened to over 21 $/t, up from an average of 5 $/t in December. The last time such high basin spreads were seen was back in November 2016, although even then the period of wide spreads was brief, with swift normalisation occurring via a repricing downwards of Pacific basin prices. The new price relativities mean that a higher carbon price will be needed to secure any given level of fuel switching. The importance for the EUA market of the coal price movements comes from how the coal price dominates perceptions around what prices will be needed to close the expected system shorts coming in from 2019. Given this, calls for any sort of serious downward price correction in EUAs does seem to be missing the option value nature of the EUA price. Regardless of developments in short-term demand-side fundamentals (which have been bearish), the EUA is also an option to emit in the future. If market participants expect that it will cost more to emit in the coming years—and we believe that it will—then discounting for the time value of money will mean that as we get closer to 2019, the option value of the EUA increases. If participants feel that current prices are below that implicit option value, then they will either refuse to sell or they will be encouraged to buy. With last week’s coal price movements increasing the implicit option value of the EUA, helping offset the weak short-term fundamentals, we continue to expect the coming weeks will trade in a range of 8.5–9.5 €/t, with an eventual movement to a higher trading range.

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