Carbon dynamics at forefront of European coal-to-gas switching

Christopher Rene


LONDON (ICIS)–The pace of coal-to-gas switching across Europe surged in 2020 with help from bullish EUA prices but it is uncertain whether the trend will continue in 2021 amid a mixed outlook for carbon and gas.

Following the initial fundamental shock of the pandemic on the wider energy complex one year ago, EUA prices embarked on a bull run which resulted in the benchmark contract discovering new highs going into 2021.

Coal-to-gas switching incentives were boosted, with relatively emissions-intensive electricity production faced with heightened fuel costs, but the ICE EUA Dec ‘21 has struggled for support lately after settling at an all-time high of €40.02/tCO2e on 12 February.


The German front-month fuel-switching costs, the theoretical EUA price required to trigger a switch from coal to gas, has ranged from -€19.75/tCO2e to €54.73/tCO2e since the start of 2020 for average coal and gas plant efficiencies.

A negative number means the fuel cost alone was enough to incetivise the switch.

Meanwhile, the German front-year fuel-switching costs have ranged from €4.48/tCO2e to €23.36/tCO2e.

In contrast, the EUA benchmark price has ranged from €15.30/tCO2e to €40.02/tCO2e for most of the period, far above the front-year fuel-switching incentive.

EUA prices historically have been highly influenced by hedging behaviour of utilities. ICIS Analytics data shows that a typical German utility does 60% of its carbon hedging a year ahead, 20% for year+2 and 10% is done three years in advance as well as during the year of delivery.

This behaviour is reflected in our hedging-weighted fuel switching costs graph.

The lower end of the range illustrating switching between a low-efficient coal (36%) and high-efficient gas plants (60%) with the high-efficient coal (45%) to low-efficient gas plant (45%) switching reflected at the upper end.

The German hedging-weighted fuel-switching cost ranged from €3.72/tCO2e to €37.32/tCO2e since the start of last year, operating below the EUA benchmark price throughout.


ICIS Analytics has identified speculative EUA buying as a key driver of the latest EUA rally from around €35/tCO2e up to €40/tCO2e. Coal and gas prices picked up the bullish trend afterwards pushing up fuel-switching costs.

The latest Commitment of Traders (CoT) report by trading platform ICE confirms that investment funds have increased their carbon net long positions significantly.

Given the current political uncertainty around the implementation of the Green Deal and the restructuring of EU ETS, the European carbon market is facing increased volatility over the course of the year as speculators anticipate regulatory reforms.

In the long term, as the supply of EUAs becomes tighter, increased fuel switching from coal to gas is required to balance the market.

This becomes more pronounced if speculative players anticipate a tight carbon market in the future and buy carbon allowances ahead. This can lead to the appearance of carbon driving fuel-switching dynamics and the wider energy complex.

In other cases, fundamental changes in gas and coal markets will overshadow speculative carbon trading.

In the short term, carbon prices could ease as technical retracement combines with the increasing lack of fundamental support due to fading weather-driven demand and renewable generation gradually rising.


The transition to warmer weather across northwest Europe should ease pressure on regional gas supply margins, removing support for gas prices which could help to maintain some incentive for coal-to-gas switching.

Gas demand should soften with natural gas storage withdrawal rates likely to fall back and ease the pressure on stocks with above-average temperatures forecast for weeks 8-9 in key markets such as Germany and the UK, according to MetDesk models.

However, European stocks have been severely depleted this winter, operating at three-year lows of 32% fullness as of 22 February, and this could limit the downside potential of European gas near curves.

The broader supply picture reveals some bearish signals , with LNG deliveries into Europe set to improve going into the second quarter and offer some respite to previously squeezed margins.

The recent cold-weather-driven US LNG supply issues are expected to have a short-lived impact on the market, with loading patterns expected to be disrupted until March, said an LNG analyst.

“I wouldn’t expect to see a short European market this summer,” added the source.

ICIS Analytics subscribers can find daily power generation and emissions data here and fuel-switching here .

Additional reporting by Florian Rothenberg


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