EUAs explored a new lower range last week, after breaking out of the technical range that had held for the better part of seven weeks in the week ending 15 February. We think that new lower range will be between 18.0-21.3 €/t, at least in the run-up to the Brexit Article 50 deadline of 29 March. The Brexit saga continues to play out in the UK, with the ruling Conservative party and the opposition Labour party losing a total of 11 members of parliament (MPs) to the new Independent Group, a collection of individuals largely opposed to a no-deal (or any) Brexit. It is hard to tell if this new group will change the political dynamic much. The party with the biggest loss is Labour (8 MPs departed), although there are reports that a number of senior Conservative cabinet ministers will resign if the prime minister looks like pushing the country to a no-deal Brexit. The upheaval in UK politics caused by Brexit is a long way from being finished, but with only 33 days left until the deadline, almost anything can still happen. As the EU’s chief Brexit negotiator Michel Barnier pointed out, an ‘accidental no-deal’ is now a material risk for both sides. Most of the risk is bearish for EUAs, with a no-deal scenario likely to lead to a big sell-off, which the market is increasingly pricing in. An extension of the 29 March deadline, which is seen as the most credible of alternative options, would likely take some of the no-deal Brexit risk off the table and could remove some of the bearishness from the market. However, gas market fundamentals remain loose (the TTF M+1 price fell by 5% w/w) and, at these relative prices, will deliver much of the coal-to-gas switch. Also, with 8 GW of solar capacity (+36% y/y) and 11.7 GW (-32% y/y) of wind capacity additions in 2018, according to SolarPower Europe and WindEurope respectively, the march of renewables continues. Another 20 GW of renewable capacity additions are likely in 2019. All in all, power sector emissions could fall by as much as 50 Mt y/y in 2019 and this will provide another headwind to gains in EUA prices this year.
|Fig 1: Option OI on ICE, Mt||Fig 2: Future Dec contract OI on ICE, Mt|
|Source: ICE, Energy Aspects||Source: ICE, Energy Aspects|
EU price action
Last week’s price action suggests that EUAs will settle in a new trading range of 18.0–21.3 €/t. The EUA options market is getting far more balanced in terms of the volume of calls against puts. While in aggregate, the ratio of open interest (OI) in calls to puts on ICE is 60:40, OI in calls dropped by 3.9 Mt over last week, but the OI in puts gained by 16.7 Mt. The options market is a useful barometer of market sentiment, and the overall bias to the bull side last year is increasingly being replaced by participants looking for downside protection. OI in the underlying derivates has also kept falling on ICE, by 6.1 Mt w/w last week across all future December-expiry contracts. This could either reflect that utilities are unwinding hedges due to more gas-to-coal switching or that more proprietary positions are being unwound—or both. One source of upside in the next few weeks might come from the 15 March compliance date for UK installations. The deadline is somewhat unique in that, due to Brexit concerns, it is both earlier than normal (the date is usually 1 May) and will occur before the following year’s free allocation. Reports suggest some companies could see a significant compliance bill this year, if they had been ‘borrowing’ from future year’s allocations to meet compliance needs. We think it unlikely that the whole compliance needs of those industrial companies will be filled in the next few weeks, as the combination of early compliance and no free allocation has been known since December 2018. Reports have focussed on British Steel, which received around a 6 Mt free allocation in 2018, as being short EUAs for compliance. But even if all of British Steel’s free allocation volume of EUAs was filled by purchases in the next three weeks, its impact on the market would still be modest.