Double Dutch

Published at 12:19 19 Apr 2018 by . Last edited 15:12 5 Nov 2018.

Another month into 2018 and the bull run that EUAs have been on appears as rampant as ever, with another 2.8 €/t or so added to the EUA price since mid-March and the Dec-18 contract flirting with 14 €/t by mid-April. We are not calling an end to the upward price movements, but a potential trigger for some sort of price correction has started to appear on the horizon. Open interest for at or in the money call options expiring on 22 June have grown over the last month and are now at 14.2 Mt. In-the-money options could be exercised for EUAs and are becoming a bigger volume for the market to absorb in one day. Further increases in the underlying EUA price could swell the volume of in-the-money call options more and could push underlying EUA prices down on option expiry day. At the very least, this would test the resolve of a market riding a real upward trend.

The market does appear to be getting a little jittery given the steepness of recent price rises. A month ago, there were around 200 Mt of underlying EUAs covered by call options and just 94 Mt covered by puts. Over the last four weeks, the number of call options has grown by 24 Mt, while the level of puts has grown by 56 Mt, suggesting a growing number of market participants are now looking for some downside protection.    

April, as always, started with the release of verified emissions data. Verified emissions for 2017 came in as we forecast in last month’s outlook, with a 0.4% y/y increase in emissions from stationary sources to 1,762 Mt. Industrial emissions were up on strong y/y growth in most of the energy-intensive sectors, although the numbers suggest that there were still some energy efficiency gains being made as emissions increased by less than growth. Despite a supportive year from weather (cold and dry) and from low French nuclear availability, power emissions ebbed on strong wind generation. The market took little notice of the verified emissions data on release day as the information was already baked into prices. 

The Dutch government announced at the end of March that it is looking to reduce output from its large Groningen gas field by around 80% by 2025 and close it by 2030. This was important for the EU ETS even though it was not a carbon policy decision. European gas prices will be higher and more volatile than expected, and have more room to accommodate LNG imports before needing to encourage extra domestic demand. Higher sustained gas prices will mean the carbon price will have to chase the gas market upwards to exhausts all the potential coal-to-gas switch.

The 2018 summer contracts at the TTF all added about 9% over the last month. This certainly pushes up the implied carbon price needed for any fuel switch in summer 2018, although the market is unlikely to need to incite much fuel switching to balance this year. The TTF Cal-19 gas contract also rose by 9%, to just over 18 €/MWh, while the equivalent for Cif ARA was up by 8%, to 82 $/t. At those price relativities, the implied EUA price needed for Europe to largely exhaust its fuel switching capability would be up at 75 €/t. That implied price is lower in the summer, with TTF Sum-19 trading at 17 €/t, which takes the implied marginal fuel switch price closer to 45 €/t.

It still feels like most of 2018 will see EUAs continue their bull run, despite a potential selling event in mid-June. For 2018, we are now forecasting a 14.1 €/t average (up from our previous forecast of 12.6 €/t), with a Q4 18 average of 17 €/t (up from 15 €/t). We now have 2019 at a 19.2 €/t average (up from 18 €/t), with 2020 at 22.8 €/t (unchanged). These revisions are largely on current market exuberance and a tighter outlook for European gas.

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