One of the weights on the carbon price this year has been Brexit risk—the fear over what will happen to the European economy and asset prices in the event of a no-deal UK exit. The perception of the risks around a no-deal scenario had grown in recent months with the deadline of 29 March for Brexit approaching and the government refusing to rule out a no deal exit. So, the EUA market reacted with palpable relief when Prime Minister May removed much of the no-deal risk late Tuesday. May did this by promising a series of votes, which will happen over sequential days from 12 March. The first one will be a second vote on a possibly modified version of the existing May Brexit deal, although no major change to the EU position on the controversial Irish backstop has been announced. The previous vote ended in parliament rejecting that deal by a margin of 230 votes. The Conservative party’s wing supporting a hard Brexit seems to now be rallying around May’s latest deal, but the prospect of it being approved by parliament seems slight. If May’s latest deal is rejected, the next vote will be on leaving the EU with no deal, which is unlikely to get majority support in parliament given the fear of the potential resulting economic chaos. The last of the three votes would then be to extend the Brexit deadline, which is the most likely vote to pass in parliament. It is unclear what would happen if that third proposal is also rejected. If passed, the government would go to Brussels to ask for an extension to the deadline. While the length of the extension is likely to be the subject of negotiation, that decision ultimately rests with the EU. The EU is likely to have two key objectives. First, it will only want to grant the UK one extension, as it does not want to repeatedly extend the deadline. This suggests a long extension, of potentially up to two years. Second, EU elections are in June and the new parliament will be sitting in September, so there would be legal issues with an EU member not having any EU parliamentary representation, arguing for a short extension.
|Fig 1: Option OI on ICE, Mt||Fig 2: EUA daily trading ranges, €/t|
|Source: ICE, Energy Aspects||Source: Refinitiv, Energy Aspects|
EU price action
The EUA market did like the announcement on the series of Brexit votes. It stopped the bear run it had been on since late January and closed Friday (1 March) at 22.28 €/t, up by 18% w/w. The news did push prices back above some key technical resistance levels, so the market is going to spend most of this week searching for a new range in which to trade. To the upside, some technical resistance is potentially at 24.2 €/t, while downside support could lurk around 18.4 €/t. That is a relatively wide range, but that is to be expected in the EUA market. Open interest (OI) did not fully reflect the bullishness last week, with OI on ICE for December-delivery contracts falling by 5.4 Mt w/w, following on from two weeks of declines before that. The options market was more bullish with a bigger purchase of calls (OI +24.8 Mt w/w) compared to puts (+5.4 Mt w/w). The single Dec-19 call strike with the highest level of OI was 50 €/t, suggesting some bulls are out there. Other fundamentals remain weak, with gas still pricing in considerable fuel switching, while coal is seeing some belated support from a rise in the price of oil. With reports now suggesting 2018 annual renewable additions in the EU of just under 20 GW, and gas squeezing out coal in power generation, power sector EUA demand will continue to be weaker y/y. The big point to watch for the market in the coming weeks is for how long will Brexit risk come off the table, as a three-month extension to the negotiating deadline has far different implications than a two-year extension regarding proprietary buy-side interest.