Brexit risk seems to be growing, with EUA prices last week testing some key technical support levels but failing to drop below the 90-day average. Most fundamentals remain bearish. The UK is still focused on the Conservative party leadership contest, with Boris Johnson the frontrunner and Michael Gove or Jeremy Hunt now the most likely to be the other candidate in the final run-off vote by party members. Conservative members of parliament should whittle the field down to the final two candidates through a series of ballots by 20 June, with the Conservative party membership then to have its final vote in July. Johnson has publicly stated that he would ensure the UK leaves the EU on 31 October, with or without a deal. Both Gove and Hunt have indicated that a no-deal Brexit was not their preferred option. Only Gove has indicated that he would consider delaying Brexit again to get a deal, although his leadership bid has been damaged by his admission that he took cocaine when he was younger. Meanwhile, in a by-election in Peterborough last week, the Labour party held the seat but the Conservatives notably lost 25 percentage points of their share of the vote compared to the 2017 election while the new Brexit Party took 29% of the vote. That result will have been watched carefully by the Conservative leadership hopefuls as it underlined that there are still large parts of the UK that want to leave the EU at the next deadline. Given very little negotiation between the UK and the EU is likely to happen before September, the 31 October deadline is likely to be tested. The implication for the EUA market is that there is no upside potential for prices outside of the current range (23.7-27.7 €/t) until that date passes. After 31 October, if the UK does crash out with a no-deal Brexit, then downside will come from that being a big risk-off event for the EU as a whole, with speculative EUA positions being dumped and UK installations unwinding forward hedges.
|Fig 1: EUA daily moves, €/t||Fig 2: EU Industrial production, y/y change, %|
|Source: Refinitiv, Energy Aspects||Source: Eurostat, Energy Aspects|
EU price action
Last week, we argued that a breakout to the downside of the range looked increasingly likely although we noted important technical support around 23.7 €/t. Last week did see the market test that downside. Within-day lows hit that level and bounced off it on three days last week. While Friday’s rally did come as the technical downside momentum looked to run out of steam, directionally it still feels that this market will be drawn more to the downside rather than the upside over the coming weeks. Summer 2019 European gas prices took a week off from falling, with the Jul-19 contract adding back 2.8%, but the outlook for that market remains bearish from even low current levels. Our current 2019 forecast is for around a 40 Mt y/y reduction in emissions from the European power sector and another 3 Mt y/y drop from the industrial sector, suggesting this year will see little to no incremental buying of EUAs for compliance. Another modestly bearish event will come next week with the expiry of Jun-19 options. At the end of last week, there was 8.5 Mt of open interest (OI) in the money for Jun-19 call options on ICE at a strike of 24 €/t or lower. OI was 5.4 Mt for put options in the money at a strike of 24 €/t or higher, suggesting a net long position of just 3.1 Mt. This is too small a volume to move the market in any material away, but it is just another reason in the next two weeks for prices to not move significantly upwards. We still expect the coming months to trade in a 23.7–27.7 €/t range, with any movement out of that range far more likely to be to the downside, at least until Brexit is resolved. For the coming week, failure to break downwards last week could support a short rally.