Hedge less spec more

Published at 08:00 20 Nov 2018 by

Please note that this will be the last Carbon Outlook of 2018. The next edition will be published in January. Carbon Weekly will continue to be published as normal in the interim. Please note users licensed for the data service can access our European ETS balance, utility hedging, European power generation data and emissions price forecasts.

The super bull run that has dominated the carbon market in 2018 is largely over for the year, but market volatility remains. The market has found a semblance of stability in a very wide technical range, with prices trading within a 15–20 €/t window. The 20 €/t level has been providing some upward resistance due to the significant high open interest (OI) in EUA call options at that specific strike price. To the downside, support at 15 €/t has been found as option expiry is unlikely to lead to much selling of underlying exercised EUAs at the equivalent strike price.    

Q3 18 investor reports were published in a flurry in the first two weeks of November. Utility power hedging continued to show signs of a slowdown in y/y terms, with Uniper, RWE, EnBW, CEZ and Engie all reporting a smaller proportion of power portfolios being hedged forward. RWE dominated interest. While RWE spread hedges for thermal power are lower y/y, the company now says it is fully financially hedged for CO2 out to the “mid-2020s”, having said in the previous quarter that it was hedged out to the “end of 2022”. We think the word ‘hedged’ here is potentially misleading, as this is something of a punt on the CO2 price. In terms of aggregate utility buying, the impact of RWE’s aggressive speculative purchasing for the future will have likely meant that overall buying of EUAs this year by the utilities will likely be higher y/y.

The UK government presented a draft Brexit agreement to the cabinet and secured its approval, although it has seen a number of ‘hard Brexit’ ministers resign in response. Despite a text that could be agreed by both sides, the deal seems unpalatable to many in the UK government, so it remains to be seen if this agreement moves forward. The UK government also further clarified its policy on carbon pricing in the UK in the event of a no-deal Brexit, saying a new 16 £/t (18.1 €/t) tax on carbon would be levied, effectively keeping UK power prices higher than those on the continent. Brexit remains a risk for the market.  

The mid-December expiry of EUA options and futures is approaching. Across ICE and EEX (making no allowances for calculation methodology differences on EEX), the OI of calls net of puts in the money at a strike of 20 €/t was 280 Mt as of 13 November. A significant proportion of that could already be covered by a call spread and the OI could be overstated given EEX’s quirky calculation. At a strike of 15 €/t, OI is just 34 Mt, with EEX having more puts than calls in the money at that price.  As such, the prevailing price at the start of expiry day will determine just how big a pricing event option expiry is going to be. The question for the market is whether it dumps down towards 15 €/t in the run-up to expiry, or whether it does that post expiry. In the last month of activity before expiry, we expect little change to the OI in calls, so we expect that actual OI levels will be similar than as they are now.

The German coal commission’s initial report in late October outlined the economic programmes that would begin to be implemented in the country’s coal-producing regions to help them transition away from mining. What it did not do was set out a timetable for closing Germany’s coal-fired power plants, with more clarity expected in the first half of December.

Until options and futures expire, we think the EUA market will continue to trade at 15-20 €/t. Afterwards, prices will start to climb again as we go into liquidity-constrained end-December.

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