Bulls of summer

Published at 11:34 19 Jul 2019 by . Last edited 11:18 22 Aug 2019.

Having tested but failed to break downside resistance at the start of June, the EUA market looked to test the upside, and a heavy early July news flow provided enough momentum to break out of its range to the upside. While prices have eased after hitting a within-day high of 29.5 €/t, that price move’s sustainability will be tested.

One development that fed the bullish move up was the European Court of Justice (ECJ) confirming the initial ruling of ExxonMobil on its case for more free allocation with regards to its attached CHP plant. The ruling was interesting in that it could lead to a significant reduction (70-80 Mt) in free allocation for 2020 to industrial participants. If there were some form of clawback of historical free allocation that was erroneous, say through a compensatory reduction in free allocation in the future, the new short created would be even larger (say 600 Mt). While the headline numbers are large, for any of these supply reductions to actually occur would likely require the European Commission (EC) to instruct member states to revisit free allocation lists and, more extraordinarily, require member states to take some form of retrospective action. We do not feel that is very likely to occur.

In contrast, the confirmation of German Member of European Parliament (MEP) Ursula von der Leyen as the president of the EC by the European Parliament on 16 July has much more potential to significantly alter the EU ETS. Of most potential importance for the EU ETS is the promise to try increasing the EU-wide 2030 emissions reduction target from 40% to 55% below 1990 levels. Such an upping of ambition would require a revision to the linear reduction factor (LRF) for the EU ETS in phase 4 (2021–30), from the current 48.4 Mt each year to around 64.5 Mt per year. Over phase four, this increase in the LRF would reduce EUA supply by some 726 Mt compared to a 48.4 Mt reduction factor.

Other news involved the draft auction regulation that set out the EUAs under the Innovation Fund. This would largely be equally monetised over 2020–30, as we expected. The draft also addressed the cancellation of EUAs for undertaking related power sector policies, which strongly suggests member states can cancel up to one year’s average emissions for any power plants they close but can spread that cancellation over a number of years. While this is a literal interpretation of the directive, it is less bullish than other interpretations.

From now till the end of August, policy development should be light as European policy makers enjoy summer break. This will limit the potentially bullish news flow that could push the market up. In contrast, Brexit will have its big moment on 23 July when the Conservative Party leadership contest comes to a close. We expect that this will be met with something of a sell-off given that Johnson is still comfortably in the lead against Hunt.

With the break to the upside, it seems like the trading range for the Dec-19 contract has a new point of upwards resistance at 29.5 €/t. With downside support likely at 25.3 €/t, we expect those two prices to set the range for the coming two months. From September, the market promises a hefty dose of volatility as Brexit developments possibly bump against new policy proposals to raise ambition from the Commission. The timing of each will be important in determining price development, but we do expect that the downside could well prevail, given the apparent willingness of Johnson to force through a no-deal Brexit.

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