On 14 February 2018, the EUA Dec 2018 hit the €10 mark, a level last seen since November 2012.

Main points

  • This year’s development so far are very peculiar with the Dec-18 trading up by 26% over the last 6 weeks and surpassing the €10 mark intraday today
  • Usually every year in January, EUA prices go down: -43% over 5 weeks in 2016, -30% over two weeks in 2017

Analysis

  • Bearish fundamentals – overall, since beginning of 2018, all carbon fundamental drivers are bearish
    • Power spreads:
      • With coal power prices down over 10% since the beginning of January, the German baseload clean dark spread lost over €2/MWh (EU Portal customers, see clean spreads)
      • With carbon prices increasing and German baseload power prices decreasing, the German baseload clean brown spread lost over €6/MWh (EU Portal customers, see clean spreads)
      • In parallel, although gas prices stayed relatively flat, clean spark spread lost around €1/MWh due to reduced power prices (EU Portal customers, see clean spreads)
      • This makes hard coal and lignite power generation economically less attractive to hedge and should reduce EUA demand from utilities
    • Weather
      • A very mild winter (relatively low power demand and high wind generation led to lower fossil generation) has led to fewer emissions, namely around 13m tonnes compared to norm weather so far in 2018 (EU Portal customers find more details in our emission update)
      • This means that the weather in January/early February is not supporting EUA demand from utilities
  • So what happened in January?
    • We think that short speculators wanted to take advantage of the usual January down trend but got caught on the wrong side of their trades when EUA did not head North in early January – this led to the closure of these positions and created additional demand
      • From €8.18 on 29 December 2017, EUA prices went down for a few trading sessions to €7.66 on 8 January 2018 before bouncing back and making its ascent towards the €10.00 mark
    • Compliance buyers on the move
      • In our opinion, neither utilities nor industrials are responsible for the extraordinary buying activity in the market in January – while the MSR is kicking off in a year time, we believe it is still too early to account for significant MSR front running
      • Utilities: we expect relatively low regular hedging activities from utilities at the moment driven by above mentioned spread and weather developments; on top we do not expect massive MSR front-running from utilities in the current over-heated market situation
      • Industrials: as for the compliance deadline coming up in April, we assume slightly increased buying activity from industrials in Feb/Mar, but not enough to push prices that significantly; furthermore, we do not expect industrials to already front run the MSR with additional demand, but expect this more towards H2 2018
    • Open interest: It´s 2014 all over again…or not
      • The last time we had such a price increase in Q1 was in 2014, right before the start of back-loading
      • In 2014, especially open interest development was outstanding during the price increase
      • The 2018 cumulated open interest development (all contracts added up on ICE), is not as extreme with only half of the OI increase since beginning of the year compared to 2014
    • New speculators are stepping into the game
      • In our opinion, new speculators are moving in, namely mid-term oriented speculators (hedge funds, investment banks, and potentially institutional investors with a 2-3 years horizon)
      • The reason for this is two fold
        • First the bullish trend initiated by EUA prices since summer 2017 has not escaped the eye of investors
        • Second, the finalisation of the Post-2020 EU ETS reform file and especially the MSR kicking in in 2019 and the permanent invalidation of allowances mean a more robust market infrastructure for long-term investors
    • New type of investors means bullish possibilities but bearish risks as well – below, we share our views on the up- and downside risks we see associated with such players
      • How much EUA buying power do those new players are willing to use in this very new market?
        • We have seen some of those players testing the water in the past few weeks, but what type of volume are they looking to secure over the short to mid-term is unclear
        • 2018 is heavy in auctions with 984.8m EUAs coming to market excluding regular selling (EU Portal customers, see overview table in our trade positions)
          • Including selling and new abatement in the pipeline, we´re looking at a long market of around 80m EUAs
          • So the question is, will those new investors have the stamina to face those auctions volumes coming out to market every week?
      • What happens if the financial markets tank?
        • Those long-term investors are heavily active on traditional financial markets
        • Tumult in the financial markets could force some investors who need money to sell performing assets (carbon) to offset losses on hard hit financial assets

Yann Andreassen is Senior Analyst - EU Carbon & Power Markets at ICIS. He can be reached at Yann.Andreassen@icis.com

This is a condensed version of our analysis for ICIS EU carbon subscribers that was originally published on 14 Feb 2018 11:11 CET.

Our ICIS EU carbon customers have access to extensive modelling of different options and proposals. If you have not yet subscribed to our products, please get in contact with Neil Dewet (Neil.Dewet@icis.com).