Challenges ahead for European power and carbon trading

This cloud has a silver lining

11 February 2009 00:00  [Source: ICB]

At least the recession is having some positive effects: lower demand should mean plunging power and carbon prices

Isabel Save and Katie Tucker/London

PRODUCTION CUTS in the European manufacturing sector are making it cheaper for the industry to emit carbon dioxide (CO2), as demand for pollution rights - EU Allowances (EUAs) and Certified Emission Reductions (CERs) - falls.

As economic sentiment plunges towards record lows, according to EU figures, some of the largest companies in the world, in the chemicals, steel, cement and pulp and paper sectors, are idling plants to save costs.

Lower production means lower emissions, and this has suddenly left a number of large industrial users with a surplus of EUAs for compliance with EU regulation in both 2008 and 2009. These companies are now selling this surplus on the market, pushing the traded price of both EUAs and CERs to record lows. "[Firms] are addressing the economic storm. Corporates in trouble want to liquidate their allowances and raise cash," says Mark Lewis, carbon analyst with Deutsche Bank.

A string of companies are simply selling what they do not need on the spot market, with a smaller number apparently buying back their positions on the forward market.

By mid-January, the most liquid EUA contract - with delivery in December 2009 - had plummeted to approximately €10/tonne of CO2 equivalent, just one-third of where it was trading last summer.

Analysts now expect the bears to remain out in force. Industrial emissions are likely to continue to fall throughout 2009, with a rise not expected until 2010, UK investment bank Barclays Capital estimates.

The unexpected production cuts are now making the EU allocation of allowances more generous than before, raising the question of whether the second phase of the trading scheme could become a repeat of the first.

During the first trading period, companies lobbying for allowances had been a bit too successful, meaning that everybody was allocated more than they actually emitted and making prices collapse to zero.

However, this should not happen this time around, traders and analysts say. Even if industrial companies are expected to have a surplus of allowances to cash in on during the whole second trading phase, the power sector is still going to need to buy in the market, they estimate.

And if power companies end up in a long EUA position as well, there is always the possibility to save up allowances for use in the third trading phase, starting in 2013, when chemical companies will be included directly in the scheme.


As we approach the end of January, traders on Europe's electricity wholesale markets are still trying to get to grips with the credit crunch. What will be the impact on demand for electricity? How long should they factor in a slowdown? And, will the current fall in industrial demand hit all European markets homogeneously?

While coal, gas and oil will continue to drive electricity prices for 2009, traders and end-users alike will have to keep their fingers on the economic pulse if they are to get any feel for what this year will bring in terms of price direction.

Already, sentiment is bearish, as longer-than-average Christmas and New Year shutdowns at energy-intensive industrial sites have weighed on short and medium-term prices. For the moment, the gloomy outlook is pressuring prices up until the summer, with players taking a more cautious outlook for the last quarter of the year, maybe banking on recovery.

But sources from large European electricity end-users have warned that despite lower-than-average consumption for January, demand could pick up in February and March, although not to traditional levels seen for this time of year. "There is only a certain amount of time a plant can stay offline and keep its place in the production line," a source said. Global steel giant Arcelor Mittal has already said it is ramping up production once again at blast furnaces across Europe, after a sharp drop in demand for steel had rendered some of its sites idle at the end of last year.

The consensus is that wholesale electricity prices still have scope to fall this year. The only visible bull on the horizon, which is not economy-related, is the weather. Whether freezing or sizzling, temperatures could shake things up come delivery.

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