Getting connected

Published at 16:51 23 Jul 2018 by

The market rebounded over the last couple of weeks, clawing back losses after the run-up to the expiry of the Jun-18 options on ICE. Since the close on expiry day (19 June), the Dec-18 EUA contract has added back some 13%, moving back above 16 €/t for closing prices in mid-July. However, the market has merely returned to where it was at the end of May.

In terms of policy developments in the last month, the UK government published a policy paper outlining the country’s main Brexit negotiating goals. While not overly rich in detail, the paper did at least touch on the options for the future EU-UK energy relationship. The government outlined that it was still considering an option that would see continued UK participation in the internal energy market (IEM) and argued in that case it would stick to a common rulebook with the EU on the technical rules for electricity trading, ‘as well as a consistent approach to carbon pricing necessary for the market to function, which, for example, could be delivered by remaining in the EU’s Emissions Trading System’. Though this was the only reference to the ETS in the document, it shows that staying in the ETS is still on the table.

The UK being in or out of the IEM will have important implications for the operation of the country’s 4 GW of existing power interconnectors and 15 GW of interconnector capacity that is under construction. Of the latter, 4.4 GW relates to four projects for which a final investment decision (FID) has been taken and are expected to be online in the 2019-2021 period. Of that capacity, 2.0 GW is with France, 1 GW is with Belgium and 1.4 GW is with Norway.

The three interconnectors set to come online in 2019-2020 in the south of the UK will help squeeze out UK gas-fired generation in those two years with power imports, resulting in UK power sector CO2 emissions falling y/y by 2.3 Mt in 2019 and 5.8 Mt in 2020. Any increase in French (and Belgian) power flows to the UK would result in reduced exports of French power to Germany. In turn, Germany would need to generate additional power, though from which source will depend on the carbon-adjusted relative prices of gas and coal—additional generation could well come from hard coal. If all the power flowing to the UK via the new interconnectors is generated by coal, then total European power sector emissions would grow by 3.0 Mt in 2019 and 7.4 Mt in 2020.

For Q3 18, fundamental buying of EUAs could be a bit stronger given the hot, dry summer that has been experienced so far in NW Europe. Taking into account all of the different ways the summer drought could impact power generation, we estimate that the hot weather could add 4–8 TWh of incremental thermal power generation over Q3 18, which equates to 2-6 Mt of additional emissions, depending on the mix between coal-fired and gas-fired generation. If the Nordic hydro balance continues to deteriorate, that could further boost underlying thermal power demand and emissions, and this effect could continue and be more acute this winter.    

There has been a rise in compliance buying. But the direction for the market still hinges on whether the conviction ‘buy and hold’ market participants have much more buying to bring to the market. We have seen some evidence that open interest in call options and in futures is still increasing, so we expect that the market has a bit more bullishness in it this year. We expect gains to be strong in August, when primary auction volumes are halved.  

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