ALLCOT EU ETS Report – June 2017

European carbon prices closed the first half of the year down €1.10/mt from their January 1 level, a drop of almost 18%. That’s less than half the 44% plunge that front-year prices experienced last year, but it still reflects a market that remains chronically oversupplied and awaiting reforms long promised by the European Commission.

The benchmark December 2017 contract ended June at €5.03/mt, roughly the same level where it began, thanks to continued demand from utilities as profit margins from burning coal remained at their highest levels for the year to date. Prices moved in a range from €4.80-5.28/mt during the month.

The last two days of the month saw carbon break out of a slow downward trend that had seen prices drift to as low as €4.77/mt. A sharply weaker US dollar depressed coal prices, and made the fuel more attractive to utilities.

As a result, German power generators saw profits from burning coal to generate power in 2018 rally to around €2/MWh, among the largest margins they have had all year. This boosted the incentive for power generators to sell forward electricity and hedge their fuel and carbon costs.

The late strength in carbon was somewhat unexpected, as most analysts and many traders had been expecting prices to decline in the second half of the month as auction supply increased.

A six-week period of daily sales starting June 19 is injecting more than 130 million allowances to the market, compared to 118 million EUAs during the same period last year

Even the annual 50% cut in auction volumes during the holiday month of August will see supply totaling 46 million EUAs, compared to just 26 million in August 2016.

The increased supply is due to the end of the “backloading” programme that withheld 900 million allowances from the market in the years 2014-2016. The 900 million EUAs were originally intended to be reinjected into the market from 2018, but the EU is currently negotiating whether this volume should instead be transferred to the Market Stability Reserve from 2019.

Analyst expectations of lower prices have so far been confounded, but many are still confident that as the supply from daily auctions mounts up and utilities begin to reduce their forward sales, permit prices will indeed fall towards €4.50/mt.

Speculative traders have had a hard time this month, with historical volatility dropping to less than 35% compared to more than 75% in March. The anticipation of lower prices had led some to take on short positions in June, and the failure of the market to drop below €4.90/mt may have encouraged some traders to cover these shorts, adding to the buying interest at the end of the month.

The outlook for July is therefore balanced to bearish, and much will depend largely on the utilities’ appetite for further carbon purchases.

Also in the mix will be the continuing regulatory process concerning the reform of the EU ETS. EU institutions met for a formal trialogue on June 27, and a further meeting is scheduled by the incoming Estonian presidency for July 10.

There was no significant change in positions among member states, the commission or the parliament, though some observers suggest that there is a growing consensus regarding some of the key reforms, including the market stability reserve and the share of permits to be auctioned from 2020.

However, a number of participants believe that there will be little meaningful progress in these talks until the outcome of the German presidential election is known in September. As the largest emitter and most influential member state, Germany’s position on key reforms is likely to be an important consideration in any final compromise.

Reported by Allcot Group