European carbon

Published at 10:49 23 Apr 2019 by . Last edited 11:18 22 Aug 2019.

In a relatively uneventful week, EUA prices settled into a new range between 26-28 €/t. With Brexit news not expected to resurface in the coming week, the market will be looking more at technicals for direction than fundamentals. Some late compliance buying could come from British Steel, a modern version (incorporated in 2016) of the old company of the same name, with assets acquired from Tata Steel by Greybull Capital. This short time in existence raises questions of why and how the group became so short of EUAs that it went looking for a reported emergency loan from the UK government of £100 million. At current EUA prices, that suggests around a 4 Mt shortage of EUAs, which is extraordinary given that total 2018 verified emissions of UK installations in the metals sector is around the 7.1 Mt level.

British Steel’s problems largely come from the reportedly common but risky practice of using the current year’s free allocation of EUAs to comply with the previous year’s emissions. With the risk of a no-deal Brexit still present, the UK has not provided installations with 2019 free allocation and will not do so until an exit agreement is reached. UK industrial installations now have to submit EUAs for their 2018 emissions at the end of the month without having received this year’s free allocation. As such, any UK installations that have been borrowing from future years will have to close that short now, in the current high-priced market. We think many of the industrials will have already been lowering the volume of borrowing as such borrowing cannot be done between phases, so the short would need to be closed for next year anyway. It is clear, though, that some UK industrials have been tardy, suggesting that a sizeable group of industrials across the EU are in similar positions and will need to close short positions. Such short-covering does promise added compliance support for EUA prices over the coming year.

Fig 1: EUA daily moves, €/t Fig 2: ICE EUA Options OI, Mt
Source: Refinitiv, Energy Aspects Source: ICE, Energy Aspects

EU price action

EUA prices showed a degree of stability last week, trading in a 26-28 €/t band. One week into a range does not confirm that trend volatility in either direction is finished, although we do not see obvious current triggers to push the market in either direction. Some upside resistance might be seen at 27.85 €/t, while downside support is likely to be strongest way down at 23.7 €/t, but neither of those are likely to be all that solid. Short-term fundamentals are unlikely to be all that supportive of compliance buying. The mid-April hot spell is going to weaken, but temperatures are not forecast to dip below normal for the rest of the month. The outlook is for windier weather for the end of the week. Gas prices did weaken in relative terms last week, so again the impact should be bearish for the market. Also, this week largely marks the end of any last-minute compliance buying from installations for their 2018 emissions in advance of the 1 May 2019 deadline. As such, any compliance buying that has helped push up prices in the last couple of weeks is likely to ease, and the market will go back to being driven by the combination of utility hedging and volatility trading. Some support might be seen from news that Poland allocated more of its free EUAs under its power sector derogation in 2018, although it still had a surplus of 11.3 Mt to add to the surplus it accrued in the 2013–17 period, suggesting it will auction 60-70 Mt of additional EUAs in 2020. The high allocation this year just makes it less likely that the volume of added EUAs Poland will auction in 2020 will be as high as our previous expectations of 100 Mt, which is at least moderately supportive. However, the next couple of weeks for EUA prices will all be about testing how strong the new range is and whether there is enough underlying capital to support its continuation. We expect trading to stay in a 24-28 €/t range for the coming few weeks.

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