EU carbon prices have surged to 10-year highs of nearly Eur26/mt in recent weeks, boosted by policy changes to tackle oversupply as part of the EU's wider efforts to combat climate change by cutting emissions. But while policy-makers are often told high carbon prices will push out coal-fired power generation in favor of gas, this is not happening yet this winter.
S&P Global Platts editors Siobhan Hall, Frank Watson and Andreas Franke examine the complex interactions between the carbon, gas and power markets, and how coal-fired power generation may still have to come to the EU's rescue if this winter includes extended cold snaps with very little wind.
SIOBHAN HALL: Hello, and welcome to this Brussels to Beijing policy podcast from S&P Global Platts. I'm Siobhan Hall, Platts' expert on European Union energy policy based in Brussels.
Today we're talking about the surge in carbon prices in the EU's Emissions Trading System, its key policy measure to cut industrial greenhouse gas emissions to combat climate change. So how are higher carbon prices impacting the European power markets? And what can we expect to see next?
To discuss this I'm joined from London by our European carbon market expert Frank Watson and European power market expert Andreas Franke.
So Frank, how have carbon prices changed recently?
FRANK WATSON: Well Siobhan, we've seen a four-fold increase in carbon prices over the last eighteen months, with prices rising from less than €5/mt in May 2017 to well over €20/mt this year.
SIOBHAN HALL: Wow, from five to 20? That's a massive rise! What's behind that?
FRANK WATSON: Well, it's being driven primarily by an expected 40% cut to carbon auction supply in 2019, which is due to the new Market Stability Reserve policy starting. But more recently, those gains went into overdrive with prices jumping to a 10-year high of just under €26/mt on September 10, and that was linked to a squeeze on September carbon options contracts which expired in mid-September.
SIOBHAN HALL: Right, so we've had a 10-year high -- have prices stayed that high?
FRANK WATSON: Well really that was a temporary factor, and carbon prices have since fallen back to around €20-22/mt. So there are two different forces – the long-term bullish trend linked to expected supply cuts, and a more short-term volatility linked to financial and technical factors.
SIOBHAN HALL: Right, interesting, so let me bring in Andreas, and ask if these higher carbon prices are driving coal to gas switching in power generation? Because in Brussels I often hear people saying that's what would happen and actually what should happen.
ANDREAS FRANKE: Well, for the moment we see very little evidence of coal to gas switching, especially for the coming winter. In fact it could be rather the opposite, despite the very high carbon prices, as European gas prices have risen more strongly than coal over recent weeks, especially in August and September. And that has improved generation margins for coal, and we now even see the oldest coal units back in the money.
SIOBHAN HALL: Hmm, so that's not the outcome people may have expected. Why are gas prices rising more than coal?
ANDREAS FRANKE: That is a good question. It's mainly down to tightness in gas market ahead of the winter. Last winter was very cold with very high gas demand, and that's very fresh in traders' memories. So gas wants to go into storage – it does not want to be burnt in power stations. This coal/gas market dynamic may change – we have seen European front-year coal prices reaching a $100/mt. But what we have seen until now is that gas has risen comparatively more than coal.
FRANK WATSON: Yes, and that demand for coal burn in power generation is also propping up utility hedging demand for carbon, which is supporting the carbon price.
SIOBHAN HALL: Right, so gas is short and it wants to go into storage, whilst there is increased coal burn in power generation, which is supporting the carbon price. So how high does carbon need to go to prompt coal to gas switching?
FRANK WATSON: Well, as Andreas said, there's no simple answer because carbon is only one element. And there are differences between each market – so the level you need in the UK is different from what you need in France or the Netherlands or Germany, for example.
SIOBHAN HALL: OK, so different countries would need different carbon price levels to even have a hope of shifting out of coal. How does that feed into the national carbon price floor debates?
ANDREAS FRANKE: That's a very interesting point. The Dutch government was looking a year ago at introducing a carbon floor price of around €18/mt, but that seems off the table for the moment for various reasons. The government has since then introduced legislation that will close coal plants anyway by 2030. One problem for the Dutch was that studies showed that much of the coal burn would simply be pushed across the borders, for example into Germany. For policy-makers there is another dimension to carbon pricing and decarbonization, and that is that subsidy-free renewables need a guarantee for investors that carbon prices won't collapse again. A carbon floor price could potentially give such a guarantee, for instance for the Dutch offshore wind farms that are planned without subsidies, but there could also be other ways to do this.
FRANK WATSON: As Andreas said, there are countries that are still looking at putting in a minimum price for carbon. I think the debate about carbon floor prices really dates back to a time when European carbon prices were seen as far too low to make a meaningful impact on clean investment decisions. And of course we're now in a very different place with carbon prices above €20/mt.
SIOBHAN HALL: Yes, so the issue there is whether it's going to stay above €20/mt, and so policy makers may still want a floor price to reassure investors that carbon prices will stay above a certain level. So let's look ahead now. Frank, what can we expect to see next in the carbon markets?
FRANK WATSON: Well we're getting nearer to the Market Stability Reserve cutting auction supply starting in January. And as we go into winter in Europe, there is potential for further price gains, particularly if high gas prices continue to help coal stay in the money for power generation. As ever, a lot will depend on weather factors, so an unusually cold winter, or an early start to winter weather this year, would be bullish for carbon prices, and the availability of wind and nuclear energy also tend to affect demand for carbon.
SIOBHAN HALL: Right, so we're all going to be watching the weather forecasts very closely this winter, aren't we? What about the power markets, Andreas?
ANDREAS FRANKE: Well, I agree with Frank, weather is key with possible price swings from changes in temperature and wind generation far higher these days. Overall, fundamentally both power and gas markets could be very tight this winter, especially if there are extended cold snaps and very little wind. In that scenario coal could come to the rescue, perhaps for a final winter in some countries, because some of those coal plants are very old now and will face increased economic pressure from those potentially continued high carbon prices.
SIOBHAN HALL: Right, so we might see more coal burn this winter, but next year could be a very different story! That's very interesting! We'll be following all of this closely here at S&P Global Platts. Thank you for listening, and join us next time for more Platts perspectives on policy.