Another month, another acceleration in the EUA bull run. While April was actually a fairly modest month for EUA price gains, with the Dec-18 contract only adding 2% over the month, May has been racing upwards, passing 14 €/t at close on 9 May and 15 €/t on 16 May.
The renewed upswing continues to run largely contrary to underlying fundamentals. While the weather has been supportive of power generation across most of this year so far, with February to April temperatures lurching between extremes, thermal power generation has been pinched this year. Across the main western European power markets, SO data puts total generation up by 8.7 TWh over the first four months of 2018 but thermal generation down by 32 TWh. The key driver has been the significant increase in low-carbon generation.
Wind power generation grew by 20.9 TWh y/y, reflecting the addition of over 20 GW of capacity additions in 2017. Hydro generation was up by 15.8 TWh, as heavy snowfall in the Alpine regions supported heavy spilling even though actual hydro levels at the end of March were no higher y/y. With the spring run-off now filling up the facilities, overall EU hydro reservoir levels were 8% higher y/y (as of week 17) and indications are that stocks are going to fill even faster in the coming weeks. Nuclear generation was up by 5 TWh y/y, driven by Germany and France.
The bull run appears also to have occurred despite less hedging activity from the utilities. The recent weeks saw most of the utilities present their Q1 18 financial results. The reports show that utility hedging is generally lighter y/y. Consistent y/y reductions are being seen in Y+1 (2019) contracts, which are now lower for most utilities than the comparative Y+1 last year. A similar pattern is seen across the Y+2 contracts. More importantly for the EUA market, RWE reported that its CO2 position was fully financially hedged until the end of 2022, with averaged prices for the 2018-2022 period in the range of 5-6 €/MWh. This suggests that whatever it is doing on its power hedges over the next couple of years could be immaterial, as any new forward power sales will not necessarily be met by a corresponding purchase of EUAs.
Calling the top of a bull run is always difficult, but certainly December holds considerable risk of profit-taking. The expiry of Dec-18 call options represents a risk as there is already some 121 Mt in the money. The expiry of those options comes three days before the expiry of the Dec-18 contract (open interest is already up by 141 Mt despite indications of lower y/y utility hedging). Those two trends together create considerable risk that proprietary volumes get sold in large volume at that time, which could end up having a big dampening effect on Q1 19 prices. With 2019 fundamentals only tightening in a gradual way, with supply dropping by just over 30 Mt y/y each month, if around 300 Mt of EUAs were to be monetised at that time it could easily take a couple of euros off the price. The subsequent recovery, coming from that gradual tightening of fundamentals next year, could well be slower as the market absorbs the volumes sold in that period and the promise of proprietary gains could be less significant.
It still feels like EUA prices will continue their bull run for most of 2018, despite that big potential selling event in mid-December. For 2018, we are now forecasting a 15.0 €/t average (up from our previous forecast of 14.1 €/t), with a Q4 18 average of 18.5 €/t (up from 17.5 €/t).