The EUA super bull run of 2018 shows no signs of slowing down despite the odd high-volatility pricing event. Prices in late September were above 22 €/t, having started the year around 7 €/t. The high sustained carbon prices are supporting related markets, with TTF winter-delivery gas prices hitting decade-highs and German baseload year-ahead power prices 50% higher than the start of the year.
With such big knock-on effects, lots of market chatter has taken place around what is a fair price for EUAs and whether or not market regulators will intervene to calm carbon prices down. In terms of whether the price is fair, the EU ETS is not yet at the point where it needs to create short-term emissions abatement to get the market to balance. However, it will approach that point over the next couple of years as the MSR operates, and market prices should begin to reflect those high costs.
The issue is finding where that pricing point that delivers short-term abatement sits. One of the key lessons of 2018 so far has been that power sector emissions are far more price-inelastic than the market expected. While EUA prices are around three times what they were at the start of the year, gas use in power has not materially increased as a result due to the tightness of the EU gas market, which is finding equilibrium by pricing a consistent but limited amount of gas plant into merit. As the EUA price has risen, gas prices have counteracted this by rising upwards in step to keep rationing the volume of gas into the power sector. Thus, the implied fuel switch prices have continuously been driven upwards as gas prices keep rising. This suggests that there is almost no carbon price that will drive the coal-to-gas switch given a fixed supply of gas.
The other place for some short term abatement might be in industry, but with low-hanging energy efficiency fruit already largely picked, it will take investment to gain more significant emissions reductions at current levels of industrial production. However, for low-margin but CO2-intensive processes such as the production of cement clinker, current market prices for both commodities would suggest selling carbon allowances rather than producing cement. While this could occur on the margins, real-world considerations mean this is unlikely to be a big source of short-term abatement. The biggest consideration is free allocation, and rules about removing free allocation from installations that see a large annual reduction in emissions mean a big sell-off of EUAs by an industrial will only occur if there is a decision to close that installation down permanently.
As such, there is no easy way for short-term abatement to occur, so this is a market that will be prone to spike. This brings us to the following question—how likely is it that regulators will intervene in the market as prices increase? The key to this answer is that the regulator can only intervene according to legislation. Under EU ETS rules, the rise in EUA prices is getting close to the point where the regulator (the European Commission) will be required to make a decision about whether it is appropriate to intervene. We expect that having spent some six years and three legislative processes (backloading, MSR, phase 4 revision) trying to change the rules to get EUA prices higher, it would be odd for the Commission to intervene at first sight of higher prices.
For October and November, we expect the speculative fervour that has gripped the EUA market will continue to drive prices upwards, and we expect prices to be regularly trading over 25 €/t by end-November, if not earlier.