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Bull market looms for dirty spark spreads as carbon back-loading begins

12 Mar 2014 06:00:00 | edem

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A bullish outlook for dirty spark spreads is looking increasingly certain over coming days on Europe’s electricity markets, if the expectations of power and carbon traders prove just.

The spread, which measures the value of electricity relative to natural gas but does not account directly for carbon costs, will increase if emissions increases lift power prices while fundamental weakness continues to depress gas markets.

Traders said on Tuesday – the eve of the effective beginning of emissions back-loading – that the supply cut, which takes effect at Wednesday’s UK carbon auction, should herald increases on carbon. Prices are predicted to rise above the crucial €7.00/tonne CO2 equivalent (tCO2e) resistance level, near to which they have hovered in recent sessions, traders said.

As recently as Monday, UK traders and analysts were citing a combination of fundamental weakness on British NBP natural gas near-curve contracts alongside carbon’s likely support of power as emerging bullish drivers for the unadjusted spark spread market ( see EDEM 10 March 2014 ).

And Tuesday’s predictions will add further fuel to the speculative fire, with the UK carbon auction on Wednesday being eyed as the spark to light it.

In the wake of the UK auction, prices are then expected to rise further the following week, because supply cuts will deepen when the European Commission and Germany also offer reduced volumes to the market.

Market sources did add the strength of an upward move over this two-week period was ultimately hard to predict, with €8.00/tCO2e – a level not seen by an EU benchmark contract since November 2012 according to ICIS data – at the top end of the range.

Traders also emphasised that, if the auction is substantially oversubscribed, this could lift prices further.

Double figures?

One UK power trader, highlighting on Monday that prices have been strong in the run-up to the auction, added in the long-term there is further room for upward potential. “Sooner or later we will have to move towards €10.00/tCO2e,” he said.

Over the first three weeks of February, the UK front quarter unadjusted spark spread rose from £5.28 (€6.33)/MWh to £7.15/MWh according to ICIS calculations, a 35% gain, supported by a bullish carbon market which lifted power relative to gas.

Back-loading kicks off on Wednesday, with the UK to offer the first reduced volume of allowances during an auction to the market.

According to the approved proposal, 400m tCO2e will be withheld from auction in 2014; 300m tonnes in 2015 and another 200m tonnes in 2016. These allowances will then be returned to the EU emission trading system (ETS) in two batches: 300m tonnes in 2019 and another 600m tonnes in 2020.

Given the reintroduction of the allowances in the second half of phase III, back-loading will merely redistribute, rather than erase, the oversupply that the market has accumulated. Also, the total 900m agreed volume is less than half the estimated 200bn oversupply.

But although the measure will do little to fundamentally change the overall balance between demand and supply on the market, the progress of back-loading has served as a signal that the EU is attempting to make the EU ETS work as its primary carbon-reduction tool, which has fed into strong bullish sentiment.

The UK auction, which marks the start of back-loading, will take place on Wednesday at 8:00 to 10:00 London time. Marie-Louise du Bois

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