European carbon prices have surged since a minor correction to €7.66 on 8 January, reaching levels above €9.50 this week. Below is ICIS' Power Perspective take on the current market situation.Main points The EU Allowance (EUA) price for the benchmark December '18 contract reached an intra-day high of €9.51/tonne of CO2 equivalent (tCO2e) on 24 January - its highest level since the end of 2012 Following a short-dip to €7.66/tCO2e in early January, EUA prices started to increase from the middle of the month, supported by the €7.70/tCO2e level on the downside and broke the €9/tCO2e level on 23 January Overall, the market has been in a steady upwards trend since May 2017 with the Dec '18 contract advancing from levels around €4.50/tCO2e to now €9.50/tCO2e Analysis On the fundamental side, recent news stories have been bearish for prices: Germany The German exploratory coalition talks of the social democrats and conservatives agreed not to reach the domestic 2020 emission reduction targets, which could have been interpreted as mildly bullish However, the potential next edition of the coalition plans a special tender for solar PV and wind, a fundamentally bearish signal The tender shall reduce between 8-10m tonnes of CO2 towards 2020 targets, targeting 4GW each of wind onshore and solar PV as well as one offshore wind project Europe The European Parliament adopted in a plenary vote on 17 January its position on the energy efficiency (35% binding at EU level) and renewable energy (35% binding at EU level) directives The parliament positions are more ambitious than the commission's proposal and the council's position and hint towards higher emission reductions in the long-run Auctions The first EUA spot auctions of the year showed an average cover ratio The exception being 17 January, when the cover ratio reached 4.03 This was interpreted by several market participants as a sign for high demand However, we had already seen last year that bids are often placed with low prices, likely to increase the bid cover ratio to suggest a high demand scenario Looking at spreads, no major changes are apparent The long-term picture shows a convergence of German clean dark and spark spreads – mainly as result of higher coal and lower gas fuel costs since February 2015 However, over the course of the last month, no major shifts were visible and if the long-term trend prevails, we expect a bearish effect on carbon due to a higher likelihood of switching from coal to gas generation The German Baseload Cal ’19 power contract steadily fell for most of January from €36.84/MWh on 2 January to €34.90/MWh on 17 January before stabilising around the €35/MWh level according to EEX data With all these fundamental factors pointing towards the downside, the most likely explanation for the upward move in carbon is the build-up of speculative positions Carbon has been in a general upward trend since May 2017, tracking the increasing certainty that the market stability reserve (MSR) would squeeze the market from 2019 Most compliance-related participants will want to see legal certainty of the TP4 reform process – this will only be with the European Parliament and Council in the next month – before changing trading behaviour However, the political deal is unlikely to be contested by one of the two institutions – therefore, some speculative participants will want to front-run the MSR effect which in our view will push prices up to €36.00/tCO2e by 2023 Overall, we think that some speculators aiming to test the market’s appetite for a bullish breakout are currently active in the EU emissions trading system. We expect more bullishness towards the second half of 2018 due to the MSR starting to reduce auction volumes as of January 2019 Six-to-nine months was historically the timeline for front-running such events for compliance companies As some early movers will likely want to go long before the general market trend turns bullish, we might see the early effects of such positioning
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