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Coal still favoured over natural gas, but capped by hydro and demand

08 May 2013 18:55:45 | edcm

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Utility demand for carbon emissions allowances could fall in 2013, as first-quarter results show a bearish combination of high hydroelectric levels and declining electricity demand. Already-weak carbon prices prompted European utilities to choose CO2-intensive coal over gas for electricity generation in the first three months of 2013, company results show.

A number of European utilities this week reported declining generation volumes, as electricity consumption weakened across Europe (see table). This is bearish for already-weak EU allowance (EUA) demand.

"Taking into account lower generation and higher hydro production - as it has emerged in the first quarter, confirming a trend that emerged at the end of 2012 - demand for EUAs from the utilities could decline by 0.2% compared with 2012," said Italian consultancy Nomisma's carbon analyst Matteo Mazzoni.

"The [expected] decline is limited, as coal will continue to be the cheapest source, further pressuring the share for gas," he added.

In 2012, the last year of Phase 2 of the EU Emissions Trading System (EU ETS), European power generators were slightly short in 2012 on the carbon market after their verified emissions exceeded their allocation by around 4 million tonnes of CO2 equivalent (see EDCM 2 April 2013).

From 2013 onwards, the power sector has to purchase entirely its allowances - with the exception of those in countries covered by the derogation, mainly in eastern Europe.

Sparks and darks

Low carbon prices and the cost discrepancy of different fuels has further pressured clean spark spreads, while boosting already-healthy clean dark spreads. As a result, electricity generators continue to be attracted to coal-fired generation, the most CO2-intensive fuel on offer for fossil-fired generation.

"The divergence between the cost of coal generation and gas generation widened in the first quarter of 2013," German energy giant E.ON said in its first-quarter results on Wednesday, pointing to factors including higher renewable generation.

The outlook for less CO2-intensive gas-fired generation remains weak, E.ON added, given the uncertain status of the back-loading proposal. The measure, to be voted on again by the European Parliament in July (see EDCM 7 May 2013), could push up carbon prices and pollution costs for utilities, consequently making coal-fired generation more expensive.

The company's results show that its European coal- and lignite-fired generation decreased year on year in the first quarter of 2013, but so did overall production.

High hydro levels

While low carbon prices continued to be an incentive for coal-fired generation, the latter did come under pressure in Europe from declining electricity demand and higher hydro production.

Italian power incumbent Enel, for instance, produced only 17.4TWh from coal-fired generation in Italy, down 11.7% year on year, its results showed late on Tuesday. On the opposite end, hydro generation jumped.

The trend of hydro crowding out coal was repeated in Spain for both power incumbent Endesa and utility Gas Natural Fenosa, the companies' results showed this week. The latter firm told ICIS its CO2 emissions fell by nearly 52% in the first quarter of 2013, without providing an outright figure.

"This [low CO2] situation will probably change during the next quarters, because hydroelectric and wind-production [levels] have been extraordinary between January and March," the company said.

Utility hedging

Despite lower coal generation, utilities are still expected to be the main players on the carbon market, as speculators are expected to exit if volatility vanishes (see EDCM 3 May 2013).

"Economic uncertainty and the risk of being downgraded are causing utilities to increase their power sales," said Matthew Gray, carbon analyst at broker Jefferies Bache, in a note on Wednesday.

"Due to continued deindustrialisation across the bloc, we see utility hedging entering a quasi-super-cycle."

Some utilities covered by the derogation, such as the Czech Republic's CEZ, have already sold their free allowance allocation for Phase 3. The company now expects to have to buy allowances to cover at least some of the emissions from its power plants in the second half of the year (see EDCM 7 May 2013). This could indicate that they expect carbon prices to continue to fall, having sold them at a higher price to buy them back later at a lower one.

If industrials, which are known to be long in the market, hold on to their surplus instead of selling it off, prices could find support from utilities that are "100% short" and "quickly consuming their Phase 2 surplus", Gray said. Silvia Molteni/Rob Songer

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