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Watch: EU carbon prices rally to four-month high

EU carbon dioxide allowance prices rose to a four-month high in July, taking support from rising power prices and ongoing negotiations to agree the rules after 2020. Little concrete progress was made at negotiations on July 10 and the market awaits the next session on September 13. Carbon prices continue to feel the effects of a huge surplus of allowances, including hefty supply from auctions in 2017 and 2018. But looming on the horizon, significant supply cuts are coming in January 2019 -– now less than 18 months away. S&P Global Platts senior writer for European carbon markets Frank Watson reports.

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Video Transcript

EU carbon prices rally to four-month high

By Frank Watson, Senior Writer, European carbon markets

Welcome to the Snapshot – our series which examines the forces shaping and driving global commodities markets today.

Carbon allowance prices under the EU Emissions Trading System have been buoyant in recent weeks, rising to a four-month high of five euros forty-eight per ton at the close on July 12.

German calendar 18 baseload power prices have also clocked up a six-month high and the profit margins for year-ahead baseload power in Germany have held up well in June and July at over six euros per megawatt-hour for 45% efficiency coal-fired plants.

All these factors are supportive for carbon prices as they suggest utility hedging demand for carbon is relatively solid for the time being. Equally, fossil fuel-fired power generation in the top five European CO2-emitting countries increased in late June and July, which is also a supportive factor for carbon prices.

However, behind these short-term price drivers, the regulatory background is also supportive over the long term. Talks between the EU Parliament and Council took place on July 10, with negotiators attempting to agree on the rules for carbon trading after 2020.

Little tangible progress was made at these closed-door talks, and the next negotiations are expected to take place after the August summer break on September 13.

At this stage, negotiators are trying to find agreement on key topics including the rules for a reserve facility to curb the supply of allowances starting January 2019; the annual reduction to the cap in 2021-2030; and on the free allocation of allowances for trade-exposed industrial sectors.

Taken together, the rules for after 2020 will certainly tighten the market, even if new factors emerge that could reduce demand.

That’s because from 2019, the Market Stability Reserve will cut supply by up to 24% each year if the cumulative surplus is above 833 million tons. In 2016, the surplus was twice that size – just under 1.7 billion tons -- suggesting the cuts will need to happen for several years to get the surplus down below the agreed level.

The timeframe for the start of that process is now well within the two-year hedging horizon for utilities selling power on a year-ahead plus one basis – Calendar 2019.

We may be facing a quiet summer with few headlines emerging on the legislative reforms. But September and October are shaping up to be quite significant for carbon prices, as the EU gets nearer to striking a deal.

This is still a grossly oversupplied market. The big question is whether the ongoing strong supply of allowances in 2017 and 2018 continues to act as a dampener on prices, or whether prices begin to rise in anticipation of the Market Stability Reserve biting into supply in less than eighteen months’ time.

Until next time on the Snapshot - we’ll be keeping an eye on the markets.