EU carbon prices top Eur28/mt on bullish long-term bets

27 August 2020 | Trading

London — EU carbon allowance prices rallied above Eur28.00/mt Aug. 25 for the first time since mid-July with the market in bullish mood on reports of financials seeing carbon as a one-way bet over the long term.

EU Allowance futures contracts for December 2020 delivery on the ICE Futures Europe exchange rallied as high as Eur28.78/mt ($32.34/mt) Aug. 25, adding to hefty gains seen the previous day.

That compares with Eur25.65/mt at the close Aug. 21 – a rise of Eur3.13/mt or 12.2% in the space of two days.

"I think the FT [Financial Times] article was the spark but we were compressing volatility-wise for a while and were due a breakout," said Ariel Perez, senior carbon trader at commodities trading company Hartree Partners.

"I think people probably threw in the towel on August going up as 2019 disappointed, so it looks like we had some shorts building in the market on both underlying and volatility," he said.

The bigger price jump occurred Aug. 24, which appeared linked to an FT article Aug. 23 suggesting some hedge funds see European carbon prices as a "one-way bet" as Europe looks to strengthen its carbon market to deliver on long-term emissions reduction targets.

The European Commission in September is set to unveil assessments linked to proposals to strengthen its 2030 emissions reduction target, which would feed into stronger carbon caps under the EU Emissions Trading System in the period to 2030.

"We have now broken out and with a busy legislative agenda in September, the market it seems is positioned accordingly," said Perez.

"I also think the strong move we've had in global gas relative to coal has supported prices and closed the fuel switching gap people had been watching," he said.

"This market is jittery but again it makes sense when you have such divergent fundamental signals between short-term bear and long-term bull," he said.

Short-term fundamentals remain bearish for carbon prices, notably a 32% increase in primary supply of EUAs from auctions in 2020 compared with 2019, and an expected massive drop in demand due to the coronavirus' impact on Europe's industrial output and air travel.

Moreover, monthly auction supply is set to rebound to 85 million-88 million mt in September to November, compared with August's reduced supply of 37.5 million mt. That's a significant year-on-year increase partly due to the addition of 50 million mt of EUAs added to auctions for the EU's Innovation Fund -- a mechanism to support innovative renewable energy, carbon capture, storage and use projects, and low-carbon innovations in the energy intensive industries.

Nevertheless, many longer-term participants appear to be looking beyond 2020 to the fourth trading phase starting January 2021, which will include tighter annual carbon caps, reduced free allocation for industry, a possible expansion into new sectors such as shipping, and a potentially revamped Market Stability Reserve which soaks up surplus supply each year.

The EU ETS -- which covers about 45% of the EU's economy-wide CO2 emissions -- is expected to play a major role in achieving the EU's stronger emissions reduction targets for 2030 and beyond.

Source: S&P Global