Despite the huge gains in EUA prices in 2018, the market consensus is bullish for 2019. That bullishness continues to stem from the expected impacts of the market stability reserve (MSR), which from 1 January will remove 400 Mt from EUA auction supply across 2019. Still, how bullish the market will be in 2019 will be sensitive to developments in Q1 19. Q1 19 is when primary EUA supply will be at its lowest, given no EUA auctions from both Germany and the UK. While there remains uncertainty over exactly when German auctions will resume, it will be one month after European Energy Exchange (EEX) gets reapproved as auctioneer by the European Commission. The UK government has made it clear that uncertainty around Brexit means that it will not auction any EUAs in Q1 19. The lack of German and UK auctions mean that scheduled auction supply for Q1 19 is 116 Mt, down by 123 Mt (51%) y/y. The implication for the rest of the quarters in 2019 is that Q2 19-Q4 19 could see some 57 Mt (withheld supply of 35 Mt from Q1 19 and 22 Mt from Q4 18) of added EUAs from Germany being sold, plus 14 Mt of withheld supply from Q1 19 being auctioned by the UK. That, of course, is in addition to the underlying baseload sales from those two countries, meaning an average increase in quarterly auction sales of 77 Mt in Q2 19-Q4 19 vs Q1 19. As such, if we fail to see another step-up to a higher trading range in Q1 19, it does not entirely rule out any further price gains but does make the substantial upward price movement that we saw in Q1 18-Q3 18 appear much more unlikely. Of course, Q1 19 does have Brexit uncertainty. A hard Brexit would have some immediate downside risk as UK installations would abruptly leave the EU ETS, triggering some selling of future hedges (we think 20-50 Mt is at risk of being sold), while also hitting economic growth prospects.
|Fig 1: Scheduled EUA auctions per week, Mt||
Fig 2: EUA daily price range, €/t
|Source: EEX, ICE, Energy Aspects:||Source: ICE, Energy Aspects|
EU price action
After a short rally in mid-December 2018 following the expiry of Dec-18 EUA futures and options contracts, which pushed underlying prices up by around 5 €/t to 25 €/t, EUAs have failed to go any higher and have started trading in a now-expected wide range of 23–26 €/t. However, fundamental support has somewhat been yanked out of the market, with a repricing downward of the relative price of gas, even against a falling coal price. With the Cal-20 TTF contract currently trading at 20.2 €/MWh and the Y+1 Cif ARA coal price at 80 $/t, we see the fuel switch as largely exhausted at a carbon price of 34 €/t. When gas (and coal) had been pricing much higher at the start of Q4 18, the implied switching price was more like 45 €/t. The long-awaited tip of the global gas market into oversupply is showing some evidence of happening now, which is helping drive gas prices down and is already pushing more gas into merit in continental European markets. A real downside concern for EUA prices in the coming two years is if gas continues to soften relative to coal, as this will drop the implied carbon price needed to get all of the fuel switch done, providing more abatement at a lower price. Still, even exhausting the fuel switch is unlikely to balance the EUA market, requiring some net draw from the credit inventory in the market. For the coming weeks though, we expect the EUA market to continue to trade in its new higher price range, between 21–25 €/t. The main barrier to further upside in the coming two weeks is the Brexit vote (scheduled for 15 January), although even if the parliament rejects the current deal, the full implications for the EU ETS are far from clear.