A version of this Spotlight from S&P Global Platts Analytics was first published Dec 1st.
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EU ETS carbon prices have soared through November to record highs above Eur75/tCO2e, driven by strong technical buying and measures announced by Germany's new coalition government to align Germany's decarbonization pathway to 1.5C.
UK ETS carbon prices have also increased above GBP70/tCO2e in November, triggering the Cost Containment Mechanism in December, which enables policy makers to consider intervention in the market to stabilize prices.
Platts Analytics plans to revise up its short-term EUA forecasts in next month's EU ETS Market Outlook in the wake of ongoing policy reforms, options trading interest and strong fundamentals.
EU ETS carbon price surges above Eur75/tCO2e
EU Emissions Trading System (ETS) allowance prices have continued to surge since the start of November, as strong technical buying and political announcements weigh in to drive prices to new record highs. Our last monthly already highlighted the growing bullish environment since the start of November with gas markets tightening further on a delayed start to Nord Stream 2, strong technical buying and rising investor activity.
Following gains to EUA prices in early November, prices closed above Eur70 for the first time on Nov. 24, at Eur72.41/tCO2e. Prices have continued to rise to a new closing high of Eur75.37/tCO2e on Nov. 30. Volume in the EU carbon market in week 47 was over 15% above the prior three weeks in November, averaging nearly 36 million, with the Dec. 21 contract traded volumes on Nov. 26 above 40 million.
The UK ETS also saw similar carbon price increases this month, with UKAs trading above GBP70, to recently close at GBP73.02/tCO2e Nov. 30, up over 40% from the start of November. UKA prices have averaged GBP60.5/tCO2e throughout November, above the GBP52.88/tCO2e trigger threshold for the scheme's Cost Containment Mechanism in December.
In response, the UK government announced Dec. 1 that the Cost Containment Mechanism had been triggered, and a decision on whether to intervene in the UK ETS market to regulate prices will be announced by Dec. 14. Intervention is not guaranteed, and according to the UK government's website, a decision will only be made to address any "sustained price movements that do not correspond to market fundamentals." Policymakers will be hoping that the issuance of 2022 free allowances in February will naturally increase the supply of allowances to the UK ETS market, and ease any fears over participants' 2021 compliance costs which fall at the end of April.
Should policymakers decide to act, the UK government will consider options outlined within the UK's auctioning regulations. This could include one or a combination of: amending the distribution of allowances auctioned, releasing allowances from the new entrants reserve and/or the market stability mechanism account held by the UK ETS Authority. Of these, the most preferable option is likely to be to increase auction volumes in Q1 2022, from those published in the UK ETS 2022 auction calendar (published by ICE on Nov. 3). This, we expect, could sufficiently help increase supply to manage the carbon price, and could be implemented before the end of this year.
Speculation over EU ETS reform
Sharp gains in EUA prices have been in part a response to trader speculation of further EU ETS policy reforms, following announcements last week by Germany's new coalition agreement to implement an EU ETS 'price floor' of Eur60/tCO2e if the EU does not establish an ETS floor price across all member states. Immediately following the announcement, EUA prices rose 5.8% to intraday trading highs of Eur73.18/tCO2e on Nov. 24.
The EU ETS does not currently operate a price floor, with market stability governed by the Market Stability Reserve, which regulates the total number of allowances in circulation in the scheme – and impacting price through supply. Germany's coalition agreement has pledged to implement "corresponding national measures (such as certificate deletion or [a] minimum price) so that the CO2 price does not fall below Eur60/mt in the long term." The specific design of the domestic measure, and when it may be implemented remains unclear.
Platts Analytics has been forecasting for EUAs to rise above the proposed Eur60/tCO2e floor price from 2022 onwards and are projected to reach nearly Eur100/ tCO2e by 2030, largely driven by the tightness from implementing the 'Fit for 55' EU ETS market reforms.
Germany is a major emitter in the EU, accounting for over a quarter of the bloc's emissions. Any further developments towards setting a price floor in Germany will continue to generate short-term market speculation for EUA prices. However, Platts Analytics does not expect that long-term market behavior is likely to change significantly in the wake of these proposals, given that the current EUA price is already significantly above the proposed floor price, and is forecasted to be maintained above Eur60 from 2022 onwards.
Germany also already administers its own separate ETS for emissions from fuels used for heating and road transport, which is set to auction allowances from 2026 within a set price corridor of Eur55-65/tCO2e.
Options trading activity grows
While fundamentals over this winter period so far have been supportive of EUAs -- i.e., periods of cold/calm weather, fuel-switching signals and lower auction volumes -- there has also been increased activity in options trading.
The total open interest for EUA call options on the December 2021 contract is now nearly 340 million mt, 150 million mt higher than the Dec 2020 contract. Strikes in the Eur76-80/mt range is the most popular, with ~33 million mt of OI in the Eur80 strike alone. Strikes after Eur80 make up less of the calls. With the Dec. 21 contract due to expire Dec. 20, nearly 70% of calls are currently in the money. This strong activity in call options could have clear implications for underlying futures prices, should continued gains in call option OI lead to additional buying of EUA futures as a hedge.
What next for carbon prices in Europe
Platts Analytics plans to revise up our short-term EUA forecasts in next month's EU ETS Market Outlook to reflect the ongoing policy reforms, options trading interest and strong fundamentals. However, as highlighted in our previous reports, coal capacity limits the upside to carbon due to recent coal plant closures, and ongoing concerns over the Omicron variant may also add a downside risk to EUA's.
The carbon market's reaction to the latest coronavirus developments so far has been limited, similar to much of last year. Volatility is likely to persist into winter as the Dec. 21 contract nears expiry and participating companies prepare to purchase the necessary carbon allowances to surrender against their 2021 emissions. The compliance deadline for surrendering sufficient carbon allowances against 2021 verified emissions is April 30, 2022.
In the UK, the government will announce by Dec. 14 if and how to intervene in the UK ETS market following the trigger of the Cost Containment Mechanism. Their decision will determine UKA price outlooks this winter.