UK energy traders gamble on carbon price floor rethink
The UK electricity market is betting against the government following through with its controversial plans to introduce a carbon floor price for the power sector, participants believe.
Traders cited a surprise flurry of deals on longer-dated spark spreads on Wednesday which squeezed the contango on the far-curve - a reversal of the pattern seen after the carbon floor announcement in March.
Some fear that the policy, part of the government's electricity market reform package, will lead to carbon leakage - the loss of energy-intensive businesses to overseas locations where carbon costs are less restrictive - at a time when storm clouds continue to gather over the domestic economy.
With EU allowances (EUAs) closing at a near three-year low on Thursday - the benchmark 2011 contract ended the day at €7.85/tonne of CO2 equivalent (tCO2e) - the impact of the policy is set to be even more pronounced, putting more pressure on the government to rethink its plans.
"The carbon floor would be a nonsense, daft move at the best of times," one UK power trader said. "Now it just looks plain suicidal."
Summer '13 Baseload prices on the forward power curve gained £4.60/MWh, or 8%, in just three sessions after the carbon floor was announced last spring (see EDEM 23 March 2011), sharpening the contango on seasonal contracts and offering the first indication of how hard major energy users would be hit by price rises going forward.
But since early August, spreads between longer-dated contracts on the power curve have steadily eroded (see graphs). The Winter '13/'14 Baseload contango narrowed from a peak of £6.50/MWh on 9 August to £4.60/MWh on Wednesday - its tightest level since late June.
But the squeeze of 29% was put in the shade by the Summer '13/'14 Baseload contango, which recorded a 48% contraction over the same period, falling from £5.70/MWh to just £2.95/MWh last Wednesday.
The surprise burst of long-dated seasonal spark trade on Wednesday encompassed all Summer products out to Summer '15, bar Summer '14; and Winter '13 and '14.
The furthest forward spark deals, on Summer '15, went through at £14.75/MWh in one 15MW clip, with two 15MW clips at £15.00/MWh. The outright power trades came in at £58.66/MWh and £59.06/MWh, with the NBP deals priced at 63.23p/th and 63.49p/th.
The spark trades triggered heavy losses on outright power contracts at the back end of the curve, with Summer '15 shedding £1.50/MWh day on day - hence the tightening of the contango. "Looking at the patterns - people are betting that the carbon floor is going to fall down," one trader said.
Closer in, the spreads between the 2012-2013 seasonal contracts have broadened in recent weeks, going against the trend at the back end.
However, this can be attributed to losses recorded on the front-summer and front-winter contracts, both of which have come under heavy pressure over the last month because of mild weather-driven losses on the front-month which have filtered down to the near-seasons.
It is almost certain that the carbon floor, which as a tax matter comes under the purview of the Treasury, will go ahead.
But with economic recovery looking increasingly fragile, the Treasury is sure to face an angry backlash from many quarters.
The government is legislating to put in place an implied EUA floor price of €18.70 (£16.00)/tCO2e in 2013 for the power sector. The implied floor price, to be charged as a tax once prices dip below the set minimum, will target a €35.05/tCO2e price by 2020.
"It's an escalator," Major Energy Users Council gas and carbon group chair Eddie Proffitt told ICIS Heren. "The real worry comes when the price jumps [each year]. That's absolutely crazy and we will be objecting strongly to it.
"We feel that the carbon floor is nonsense and shouldn't have been introduced in the first place."
The Treasury failed to return ICIS Heren's calls on Friday.
Association of Electricity Producers chief executive David Porter said the group's members had "different opinions" about the policy. "The government must be honest with all electricity customers about the cost implications of both a massive building programme of new infrastructure and the mechanisms that support the reform of the electricity market," he said.
But despite growing opposition, and the market's gamble, the Treasury seems certain to hold its nerve and go ahead with the floor.
"A u-turn at this stage would be some back-track," one utility trader said. "I can't see it being pulled." JS
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15 Sep 2014 05:00