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Analysis: Correlation between carbon and German power prices turns negative in June

17 Jun 2013 20:36:58 | edcm

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The correlation between emissions and German electricity prices turned negative in the month to date for the first time in 2013, ICIS data shows, as the power front-year Baseload follows the bearish coal market.

The coefficient of determination - a method of measuring the link between two data series over a specified period of time - between Dec '13 EU allowance and Calendar Year 2014 Baseload in Germany dropped to an average -0.5 from 1-14 June from 0.6 in May, according to ICIS data (see graph).

Within this method, the closer the figure to 1.0, the stronger the positive correlation; the closer the figure to -1.0, the stronger the negative correlation; the closer the figure to 0.0, the weaker the correlation.

In the first four months of the year, the power and carbon contracts correlated with an average 0.9 - a threshold most statisticians call very strong.

"The reasons I see behind the carbon-German power positive correlation first declining, and subsequently turning negative, are connected to a continued decline of German power Cal '14 [Baseload] as well as CIF ARA Cal '14, and the simultaneous recent rise in carbon prices, partly spurred by renewed hopes of a successful outcome of the back-loading 'fix'," said Paolo Coghe, European power, coal and carbon senior analyst at French bank Societe Generale.

In the first four months of the year, the carbon benchmark shed €3.55/per tonne of CO2 equivalent (tCO2e) with the German front year declining by €6.45/MWh. Since the start of May, the carbon benchmark has picked up €1.65/tCO2e while German power's softened by €0.20/MWh.

Policy, coal are main drivers

The reversal of the positive correlation came as carbon has recently been increasingly driven by policy developments, while German power was driven by the coal market. From 1-14 June, the correlation between Germany's front year and CIF ARA's front year averaged 0.9. It was 0.3 in May.

The correlation between carbon and the fuels complex had already started to erode in May (see EDCM 22 May 2013).

Carbon prices have recently been supported by a wave of speculative buying in the run up to the second vote of the European Parliament on back-loading. In week 24 alone, the emissions benchmark rose by 16%.

"Speculative money has come back to this market again," said Coghe. However, he added: "Carbon being up doesn't actually mean the market expects back-loading to pass, but simply that traders are happy to sell back contracts, which they bought at a much lower price."

German power instead has mainly looked to coal recently, said Trevor Sikorski, head of natural gas, coal and carbon research at consultancy Energy Aspects.

The coal benchmark is being pressured by continued oversupply in the international market. CIF ARA Cal '14 shed $4.70/tonne since the start of May to 14 June, ICIS data shows. Market sources said the fall in coal prices has prompted more hedging of German dark spreads, as profit margins for coal-fired plants grew.

Looking ahead, Coghe said it is difficult to say how the correlation between German power and carbon will evolve.

"Even assuming that the picture for coal and power will not change ie if German power and coal will continue to decline then it will all depend on what will happen to carbon. And this depends mostly on the outcome of a European-level political process, which at the moment is too close to call." Silvia Molteni

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