The April relief rally has run its course and EUA prices have settled in a new range between 24-28 €/t. Signals that could cause the market to break out to either side of that range are limited. The key bull feature remains the MSR, which will remove almost 400 Mt out of the 2019 market. Those constraints are being made more pertinent by the lack of UK auctions, which will take a further 75 Mt or so out of the market. However, outside of the supply constraints, the market has few other bullish features.
Brexit risks, which weighed heavily on the market over the first few months of 2019, are coming back into view. The UK parliament is expected to vote on the Withdrawal Agreement Bill in the week starting 3 June, and while it has a number of added features aimed at garnering support, it still remains most likely that the bill fails to pass through the House of Commons. If it is approved, the EUA market could rally again as that would pave the way for a managed Brexit transition. If it is rejected again, risk of a no-deal Brexit will increase, which will largely stop a break out of the range to the upside.
Power sector emissions in 2019 are still looking less supportive for EUAs, with another 40 Mt drop in emissions likely to come from more wind and nuclear generation, and coal-to-gas switching. The large amount of coal-to-gas switching in the summer that we have been expecting is now coming to fruition, as gas prices have taken another step down on a very well-supplied market. With Cif ARA seeing some resistance to the downside as it nears the average delivered cost of coal into Europe (at around 60 $/t), the gas market is now pricing at a relative level that should allow most of the realisable fuel switch in Europe to be achieved. Power sector compliance demand in 2019 will be almost 100 Mt lower than in 2017, also lowering future hedging demand.
The Q1 19 utility investor reports were published over the last four weeks and the overall position suggests a slight y/y increase in power hedges as a proportion of utilities’ portfolios. The large rise in carbon prices, which has helped push up power prices, has encouraged higher levels of hedging generally y/y as companies are more keen to lock in higher prices, particularly for generation which is less carbon-intensive. Where utilities have locked in low carbon prices as part of their hedges, they have been very keen to let investors know.
While compliance hedging has risen to help balance out the reduction in underlying thermal generation, indications suggest less proprietary buying y/y. The level of open interest in the futures contracts on ICE and EEX was over 150 Mt lower y/y, and while OI on options was still higher y/y, by around 64 Mt, most of that reflects a much higher starting point on 1 January for options at the start of 2019 compared to the start of 2018. The size of that y/y surplus has been declining and no single strike price has yet to dominate OI, in comparison to last year’s dominant 20 €/t strike.
The EUA market has jumped up to a higher trading range and we expect that EUAs will cycle in a 24-28 €/t range for the quarters of summer 2019. We stressed last month that while no-deal Brexit risk has been moved further down the road, it is not off the table. If the 4 June vote fails to pass in the UK parliament, Brexit risk will become more important again and will do its best to stop the market from breaking out to the upside. If at any time a no-deal Brexit starts to look most likely, then a break out to the downside will be on the cards.