European carbon prices reach new highs amid cold spell, auction drought

LONDON (ICIS)–European carbon prices touched new highs as colder temperatures set in coupled with the first auction for 2021 only taking place later this month.

Week 2 Outlook

The bullish undertone in the market prevails, with the current auction drought and a supportive energy complex as short-term drivers, fueled by optimism following a Brexit deal late last year amid the prevailing cold spell. Nevertheless, the pandemic might act as a potential party spoiler, at least injecting quite a bit of volatility at the start of 2021.

Reaching all-time highs above the €35/t level means uncharted territory northwards, that could lead to a few corrections over the next weeks. Current levels look like some short-term profit taking might be possible, also as technical indicators signal a “close-to-overbought” market and as temperatures are expected to rise as of next week. From a technical perspective, the Dec-21 contract is trading against psychological resistance levels usually at round numbers. Support is found at €34.86/t and €32.5/t.

That said, the start of phase 4 of the EU ETS will produce a tight market balance and discussions around the 2030 target implementation and the MSR review will provide the background music for next year. This is reflected in a very call-dominated open interest in the options market, with strike prices ranging towards €55/t and above for the Dec-21 contract.

Week 1 Overview

Following a short period of profit-taking towards the end of 2020, the EUA Dec-21 contract started the new year with a continuation of the bull-run that started early November last year. The benchmark EUA contract closed at a new all-time high of €34.86/t on Thursday, trading above the €35/t level at the time of writing with the absence of auctions and weather below the seasonal average driving the market.

Energy complex

The continued bullishness in carbon is supported by developments in the wider energy complex, with key energy contracts reaching multi-month highs this week.

Gas remained on the upward pointing price trajectory towards the end of the week, shrugging off Tuesday’s correction to close at €19.261/MWh on EEX on Thursday. The bullish reaction in gas prices came as a reaction to a price increase for Asian LNG amid stable winter demand.

German power reacted to the positive sentiment ignited by the wider financial markets as well as bullish carbon and fuels. The Cal’21 contract closed at €53.01/MWh on Thursday, showing a third attempt to break higher within a two-week period.

Meanwhile, the API2 Cal’22 coal contract was at its highest since more than a year on Monday, before dropping a bit lower throughout the week.

Following the strong bullish push for all spreads towards the end of 2020, the increase in fuel prices amid a supported but relatively neutral power price development at the start of 2021 cause all clean spreads to correct lower over the course of week 1, with losses being very limited though.

Policy

With the last-minute trade deal reached on Christmas Eve between the UK and the EU, the Brexit-related divorce also results in a separation of the UK installations from the EU ETS as of 1 January this year. However, the UK government does not expect UK Allowance auctions in its newly created scheme to take place before Q2 2021 and free allocation is unlikely to be distributed much earlier. Therefore, at the start demand for UK Allowances will build and the first auctions are likely to be oversubscribed. As a consequence we expect UK allowances to seek price direction from EUAs especially as many utilities have logged in their power forward hedges with EUAs and will probably continue to do so for the time being.

Overall, we still see a linkage as highly likely given the pressure from UK operators concerned about an illiquid standalone system as well as the strong political statement of intent from both sides. We see two standalone systems as a mid-term bullish factor for the EU ETS due to the overproportioned reduction of the EU ETS cap as the UK leaves the system. In case of a re-linkage, the then reduced UK cap compared to what was previously foreseen as the UK share of the EU ETS cap, would support a bullish view. However, the overall impact of a linked system remains unclear as there is still information missing on how the proposed UK ETS cap would come to the market.

Macro environment

The approval of the Moderna vaccine for the EU as well as US Senate election results drove wider financial markets and had a knock-on sentiment effect on the energy complex. The German DAX stock index trades above 14.000 points for the first time in history on Friday morning.