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Listen: Tighter EU carbon market set to prompt more power fuel switching in Europe

2019 is set to be the year that coal-to-gas switching in power generation takes off in continental Europe. Carbon prices supported by the new market stability reserve cutting supplies, coupled with potentially lower gas prices, could prompt unprecedented coal-to-gas switching volumes, according to Platts Analytics. S&P Global Platts editors Siobhan Hall and Frank Watson discuss the market fundamentals and complex interactions between carbon, gas and coal prices driving power generation fuel choices.

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Hello and welcome to this Brussels to Beijing policy podcast from S&P Global Platts. I'm Siobhan Hall, Platts' expert on EU energy policy based in Brussels, and I'm joined from London by our European carbon market expert Frank Watson.

This past year has been one of the most exciting in the European carbon markets, with prices rising to 10-year highs of up to Eur26 per metric ton in September. Much of the long-term rise was because of the market anticipating the new market stability reserve that starts in January. Higher carbon prices have major impacts on generation fuel choices, and 2019 is set to be a very interesting year for the European power sector.

So Frank, what can we expect in 2019?

FRANK WATSON: Well, what we're likely to see in 2019 is something new, which is coal-to-gas fuel switching for power generation in continental Europe.

SIOBHAN HALL: Now we've already seen this in the UK, haven't we?

FRANK WATSON: Yes, the UK used a carbon price support, which is a tax on CO2 emissions, on top of the EU carbon price. And that combined price on carbon was enough to push most UK coal plants off the grid for much of the year.

SIOBHAN HALL: But you're saying in continental Europe we're going to see the EU carbon market alone driving fuel switching?

FRANK WATSON: Well, actually it's the combination of the carbon price and underlying shifts in generation fuel prices. In 2018 the price of gas in continental Europe was too high relative to coal to make fuel switching economic. But in 2019, as the market stability reserve kicks in, tightening supply for carbon allowances, this is likely to support carbon prices at these higher levels of around Eur20 per metric ton.

SIOBHAN HALL: So we do have any forecasts on how this could play out?

FRANK WATSON: Well according to Platts Analytics, the strength in the EU carbon price is a major driver of why they forecast a high level of coal-to-gas switching in the mainland European power sector next year. Another major driver is Platts Analytics' below market forecast for Dutch TTF gas prices. Cheaper gas prices would allow fuel switching to happen at a lower carbon price.

SIOBHAN HALL: Right, so we need to watch the gas, coal and carbon prices. How much coal to gas switching could there be?

FRANK WATSON: Well, Platts Analytics is forecasting an average 6 million cubic meters per day of coal to gas switching in the mainland northwest European markets in 2019, based on current market fuel and carbon prices. But this figure rises to an unprecedented 45 million cubic meters per day when using Platts Analytics 2019 Dutch TTF gas price forecast, with strong switching forecast through both summer 2019 and fourth quarter 2019.

SIOBHAN HALL: Wow, so the coal-to-gas switching volumes with the Platts Analytics' forecast lower TTF gas price could be nearly eight times the potential volumes under current market conditions. What would that mean for demand for carbon allowances?

FRANK WATSON: Well, Platts Analytics see that as implying a sharp drop in demand for carbon allowances from next summer as generators switch from coal to gas, but then that would also push carbon prices down, thus slowing the rate of coal-to-gas switching.

SIOBHAN HALL: OK, so the market is self-correcting – as high carbon prices drive more coal-to-gas switching, we see coal plant demand for allowances falling, and that softens the carbon prices again.

FRANK WATSON: Yes that's right, the markets for coal, gas, carbon and power are constantly influencing each other. According to Platts Analytics, if the carbon price fell back to €15 per ton, for example, they see about 10 million cubic meters per day less switching using the Platts Analytics gas price forecast, whilst using the market gas price in this scenario they see almost zero switching.

It's also worth pointing out that some other analysts think the market short will be so large in 2019 that even complete coal-to-gas fuel switching will not be enough to clear the market, pushing carbon prices up above Eur40 per metric ton. But that's an outlier – it's not reflective of what most analysts having been saying so far. It's a reminder that there's a broad range of forecasts out there and analysts are reaching quite different conclusions when interpreting supply and demand factors in 2019.

SIOBHAN HALL: So, what other factors could determine how carbon prices evolve next year?

FRANK WATSON: Of course, as well as underlying gas and coal price dynamics, the carbon price in 2019 will be influenced by outside demand factors such as winter temperatures across Europe, nuclear power plant and wind and solar power availability, and all this against a backdrop of fossil plant closures.

So while the supply side is undoubtedly tightening in 2019, the demand side is loosening as Europe continues to decarbonize, with about 15 gigawatts of thermal generation closed across Europe in 2018 and roughly 5 gigawatts of coal plant expected to close in 2019.

SIOBHAN HALL: Right, so like I said, 2019 is shaping up to be another interesting year for the European power and carbon markets, and we'll be following all the developments very closely here at Platts. Thank you Frank for sharing your insights, and thank you for listening. Join us next time for more Platts perspectives on policy.