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EU CO2 prices could reach Eur25/mt by 2023: JP Morgan

Highlights


EU ETS reform finally becoming 'effective'

'Excessive' surplus seen eliminated by 2023

Price still exposed to short-term downside risk

Carbon dioxide prices under the EU Emissions Trading System could rise as high as Eur25.00/mt (around $29.30/mt at current rates) by 2023 -- more than three times the current price -- as the EU finally delivers effective reform of Europe's carbon cap-and-trade system, JP Morgan analysts said in a note Friday.

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Officials from the EU Parliament and Council are set to meet late October 12 in what may be the last negotiating session to agree a draft compromise deal to overhaul the 12-year old EU ETS, following years of oversupply.

"We see a growing probability that the European Union achieves effective reform of the CO2 market before year-end. This could be announced as soon as October 13," the bank said.

"While CO2 prices may stay volatile over the next 12 months due to short-term supply and demand dynamics, we believe that reform could push the CO2 price to Eur25/mt by 2023 (vs Eur7/mt now)," it said.



"Investors have heard about possible reform of the EU ETS before, but previous attempts have failed to bring structural change to the market amid pressure from Eastern European countries and the industrial sector," it said.

"However, the EU's reform efforts have not stopped. Both the EU Parliament and Council support a doubling of the rate of allowances injected in the Market Stability Reserve (MSR) to 24% from January 1, 2019," the bank said.

"This would eliminate the excessive surplus of allowances by 2023, on our estimates. We believe that France and, increasingly, Germany are lobbying hard for an agreement that would include compensation to Eastern European countries and the industrial sector to alleviate the impact from higher energy costs," it said.

Carbon allowances prices are unlikely to move in a straight line, however, and could still come under pressure in 2018 before the Market Stability Reserve starts to reduce the oversupply the following year, the analysts said.

"We assume that CO2 prices could be under pressure in 2018, likely still a year of incremental oversupply. However, we may be too conservative in our assumptions, as utilities may start to change hedging strategies to capture a low CO2 cost while possible," the bank said.

Carbon prices could show very different performance in the first half of 2018 compared with the second, the analysts said.

Next year will be oversupplied by around 150 million allowances overall, unless utilities significantly change their hedging policies to try to capture a relatively low carbon price while it lasts, they said.

"Our central case scenario is that carbon prices drop back to mid-single-digit levels in H1 and gradually grind up through H2 as we get closer to the start of the MSR on January 1, 2019," they said.

"This is the basis for our estimate of an average price of Eur10/mt, where we see more downside than upside risk if utilities' strategy does not change reasonably soon," they said.

"More importantly, if an agreement is reached, we expect utilities investors to discount a greater probability of higher power prices in the medium term," it said.

"While taxes and faster renewable development could remove some of the benefit in the long run, we believe a high carbon price is a positive for most European power generators," it said.

The analysts highlighted French state-run utility EDF as their top pick within the European power sector, pointing to its large position in low-carbon nuclear power generation, increasing its exposure to the bullish power price impacts of higher carbon prices relative to the wider sector.

The research was produced by JP Morgan European utilities analysts Javier Garrido, Vincent Ayral and Christopher Laybutt.

--Frank Watson, frank.watson@spglobal.com
--Edited by Maurice Geller, maurice.geller@spglobal.com