The super bull run that has dominated the carbon market has taken an extended breather over October, with the market as interested in testing technical lows as it is returning to its uptrend. If the three days of hyper volatility in early September are stripped out, the EUA market has now sat in a range centred around 20 €/t since the middle of August. With 20 €/t being significant due to the high volume, estimated at 35 Mt, of open interest (OI) at that specific strike price, recent market volatility has been anchored to that strike.
The stalling of the bull run does suggest that we have not seen a significant new wave of speculative capital to push the market up to the next price level. With the upward trend looking far less firm, new investors may be concerned that the big potential gains in the market are over, at least for now.
The market faces a mix of bullish and bearish drivers in the coming months. The most bullish of these is the suspension of the German auctions, with the last one for this year being scheduled for 5 November. This will drop weekly EUA auction volumes by 4.6 Mt compared to the average level this year. In the ‘not bearish but not bullish’ category is the fact that the recent stalling of EUA price gains has made the triggering of Article 29a, which would make the European Commission debate a supply intervention to cool prices, rather less likely, at least in Q4 18.
Also potentially bullish would be a deal on Brexit that would at least rule out a no-deal Brexit. The UK government released a paper mid-October which outlined that in the event of a no-deal Brexit in March 2019, UK installations would leave the EU ETS and the UK government would regulate emissions using the carbon price floor price tax. Given this, and the political developments on the negotiations, we have revisited our analysis on the impact of Brexit on the EU ETS. While we still deem a deal as more likely (60%) than no deal (40%), we think that the eventual UK ETS option is now far more likely (70%) than the retained EU ETS participation case (30%). Given that either of those options will require an extensive deal to be agreed, we now think the conditional probability of UK installations actually staying in the EU ETS is a meagre 18%.
Against the potentially bullish drivers is the spectre of the Dec-18 expiry of options and futures. There was OI of 246.7 Mt on ICE Dec-18 call options on 19 October, with 142 Mt in the money at strikes of <20 €/t and another 25 Mt added to that at a strike of 20 €/t. The market has needed to digest revelations that EEX was reporting gross OI rather than net OI, which is the convention of other exchanges. This has meant that EEX net OI may be considerably less than the gross numbers it is reporting. The gross figures for EEX are 129 Mt in the money at strikes of <20 €/t and another 67 Mt added to that at a strike of 20 €/t, which means that at a price just above 20 €/t, around 200 Mt of underlying EUA contracts on ICE and EEX are at risk of being sold back into the market at expiry. As such, this holds large downside price risk.
For October and November, we are now less convinced that the speculative fervour that has gripped the EUA market will continue to drive prices upwards or that prices will be trading over 25 €/t by end-November. Instead, the loss of upward momentum could be hard to get back given a big downwards pricing event on the horizon. Given the significant OI in call options with a 20 €/t strike, the market could well continue to trade around this level for the rest of this quarter.