Blowing bubbles

Published at 17:54 26 Mar 2018 by . Last edited 15:12 5 Nov 2018.

The 2018 rampant bull-run that EUAs have been on did not abate at all this month, with another 2.0 €/t to the EUA price, leaving the Dec-18 contract trading at above 12 €/t as March comes to a close. The big future short positions in the market retain a pull on the market, with growing open interest (OI) (in both derivatives and options positions) and evidence of slowing hedging, providing some justification to viewing this price climb as being proprietary led.

The market is now awaiting the 3 April release of verified emissions data for 2017, which we expected to show a modest 7 Mt (0.4%) y/y increase in emissions. While the data release is a big event in the calendar of any market analyst, prices rarely move on the numbers—all the information is already baked into prices.

The increase in emissions came despite a small y/y reduction in power sector emissions. While thermal generation was up by around 16.5 TWh (1.3%) y/y, coal-to-gas fuel switching meant that total emissions fell by around 5 Mt (0.4%) y/y. Emissions from gas-fired generation were up by around 13.5 Mt y/y and lignite emissions by 4.5 Mt y/y, while coal emissions were 23 Mt lower y/y.

Over 2017, industrial output has seen the highest y/y growth in each of the energy-intensive sectors seen since at least 2010, with the only exception being refining. While we expect to see modest cross-sector efficiency gains, we think industrial emissions grew by 12 Mt (2.2%) y/y.

We take a closer look this month at the Energy Efficiency Directive (EED) revision that sees the usual target as being the source of debate. The initial European Commission proposal was for a 30% binding EU-wide energy efficiency target for 2030, while the European Council's agreement in 2014 was for a 27% target for 2030 (to be reviewed by 2020 with a 30% target in mind), and the European Parliament called for a 40% (now down to 35%) binding target. The EED will be extended and will help keep power sector demand limited, even when transport starts adding demand.

This month we saw that Brexit still has the potential to cause some disruption. In late March, the UK energy minister Claire Perry indicated that the UK intends to remain in the ETS until at least the end of Phase 3 in 2020. This was the clearest statement form the government on this, and it is clearly in line with our expectations that UK installations would not be withdrawn from the scheme before that time. While that was a form of clarity, the minister suggested that it was far from certain that UK installations would be remaining in the scheme post 2020. While logic suggests they should, there is precious little logic to any aspect of Brexit. We see it being no better than 50/50 on UK installations being in the ETS in Phase 4.

With prices still on a steep climb, the mix of current weak fundamentals in 2018 with a much tighter 2019-2020 period suggests a bit of a proprietary bubble is building. However, we do not see a trigger event to burst that bubble happening soon, so we think a big sell-off is unlikely and downward price movements will thus be limited. For 2018, we are now forecasting that EUAs will average 10.6 €/t (up from our previous forecast of 8.8 €/t), with a Q4 18 average up at 15 €/t (up from 12 €/t). We now have 2019 at an 18 €/t average (up from 14 €/t) and 2020 at 22.8 €/t (up from 16.4 €/t). These revisions are due to both the exuberance of the current market and as coal has established itself down at 80 $/t.

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