CO2 Market

An extraordinary compliance month


In the last couple of years, the number of EU ETS installations that leave their compliance purchases for the last month of the compliance period decreased continuously. History proved that it can be a risky strategy speculating on declining prices. 2019 was an excellent example, when some market participants forecast the carbon price to fall in spring as UK installations were expected to sell their allowances before leaving the EU. The Brexit deadline however has been extended (until October first and then until January 2020) and the expected decline in the carbon price did not happen.

Leaving compliance for April was not a good strategy this year either. The most liquid carbon contract increased to 22.55 euro during the month and it gained 10.7% from end of March.

The carbon price received an unexpected boost from German and French power prices during the month, after EDF informed in several announcements that it expects nuclear production in France to decrease significantly this year. The old nuclear plants require frequent and regular safety checks in order to receive an operation licence from the nuclear authority ASN. This year’s lockdowns because of the Covid-19 pandemic limited the number of available personnel to do the regular checks. The operation of the plants from autumn therefore became questionable. Should EDF have fewer capacities than needed, France will have to import power from neighbouring countries, mainly from Germany where a significant share of power still comes from fossil fuels. This additional demand could increase emissions in Germany and also lift utilities’ appetite for EUAs.

The carbon price also observed an upswing in April, when governments started drafting plans about lifting lockdown measures introduced because of the pandemic and restarting their economies. There is a risk of a new wave of infections, but the other option is slipping into an even deeper economic recession. The EU and eurozone economies will contract at record rates this year, according to the latest projection from the European Commission. It sees real gross domestic product (GDP) in the EU27 contracting by 7.4%. For the eurozone this contraction is 7.7%, broadly in line with the most recent forecast from the IMF. The commission then sees inflation-adjusted EU GDP growth of 6.1% in 2021.

The commission noted variations across the EU27 because of the degrees to which the Covid-19 pandemic has affected different countries and because of the relative strengths and weaknesses of member states’ economies. Greece (-9.7%), Italy (-9.5%) and Spain (-9.4%) perform worse than Austria (-5.5%) and Poland (-4.3%). Germany faces a 6.5% GDP cut, and France faces an 8.2% cut.

In the second half of April, the price of emission allowances showed a stronger than usual correlation with the price of Brent. Oil prices have been always considered as a good proxy to estimate economic health. The pandemic reduced demand for oil significantly. Airlines had to ground almost 100% of their planes, citizens in lockdowns use their cars less and as many companies halted their production, there were less products to ship as well. As a consequence, inventories in the US grew in a way that sellers of oil for May delivery paid for not having to store the not needed fuel. The Brent fell as low as 18.73 USD per barrel from levels above 30 USD in the first days of the month. The American WTI contract traded in the negative territory for the first time in history.

The dramatic decline in oil demand was a warning signal for lower emissions and the price of the EUA Dec20 fell below 20 euro by the end of April.

2019 verified emissions and the TNAC

According to the official data from the European Commission, emissions of greenhouse gases of the EU ETS installations in 2019 fell overall by 8.7% compared to 2018 levels, as a result of 9% decrease of emissions from stationary installations and a 1% increase of emissions from aviation.

The reduction of greenhouse gases emissions in 2019 took place in the context of a growing EU economy (EU28 GDP growth of 1.5% in 2019). The biggest reduction was achieved in the power sector with a decrease of 15% reflecting decarbonisation from coal being replaced by electricity from renewables and gas-fired power production. Emissions from industry decreased by 2%. Emission reductions have been observed in most industrial sectors, including production of iron and steel, cement, chemicals and refineries. Verified emissions of greenhouse gases from stationary installations (power plants and manufacturing installations) amounted to 1.527 billion tonnes of CO2-equivalent in 2019.

After the expiry of the compliance deadline 30 April, the European Commission is able to calculate the allowances surplus in the system, the so-called total number of allowances in circulation (TNAC). The calculations take into consideration all allowances issued via free allocation or auctioning since 2008, the used linking capacity and the verified emissions of the installations starting from the same year. The 2018 TNAC reached 1.654 million. The number serves as basis to define the number of allowances the market stability reserve absorbs from September to August by taking 24% of the TNAC from the auction volume.

As the decline in 2019 emissions was higher than the overall reduction of the system’s cap, the surplus should have increased last year. An important parameter of the calculations will be that the UK did not distribute any allowances last year, reducing the supply side of the market.

What caused the relative resilience of the carbon market in April?

Considering the dramatic unemployment numbers, company announcements asking for a bailout and the forecasts about a recession, the relative strength of the European carbon price is really surprising. On the other hand, the traded volumes do not indicate any “panic buying”.

There are some reasons I can think of that might be supportive for the carbon price.

Many companies adopted a long-term view and considering the upcoming changes of the EU ETS that will result in lower EUA supply, they prepare for the future already. They have seen the price at 25 euros and higher and think that the reforms will lift the price again. For this reason, whenever the price falls to acceptable levels (for example below 20 euros or below the 30-day moving average), they start purchasing. They are also uncertain about their future free allocation as they only know there will be changes.

And even if they do not think 2-3 years ahead, just one, they know that next April there will be no “borrowing” (they cannot use February 2021 free allocation to cover 2020 emissions). Those companies that used to borrow in the past might have accumulated a significant shortage they try to fill now.

It is also possible that the market has less sellers by now. Those companies that needed cash in the first days of the pandemic and had some surplus allowances might have sold what they had and by now they either restarted their business and have revenues from their normal operations or they went bankrupt or simply there is nothing left to sell.

We should emphasise however that the situation is still fragile. For example, a second wave of infections could put the carbon price on a steeply declining slope again.