CO2 Market

EU ETS: Coronavirus might have a more significant impact than brexit

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Since 2 January, 2020 the price of the benchmark carbon contract moved in a range of 3 euros, between 22.90 and 25.90 euros. On 21 February, before the publication of the British auction calendar the price closed at 25.63 euro. The next trading day was Monday, 24 February when the price plummeted by more than 4%.
At first sight, this could be attributed to the publication of the British auction calendar, but actually the much awaited information was positive. The publication of the calendar reduced the uncertainty about volumes and their distribution among market participants. The 5.7 million volume offered in auctions is slightly lower than expected by the market. Traders also appreciate that the 2019 volume has not been frontloaded, but the volume has been distributed equally during the year. The one EUAA auction instead of the previously announced two could also have had a bullish effect on prices. Unfortunately, the number of corona virus cases in Europe increased in the last days of February and the negative global investor mood sent all markets lower, including the carbon market.

Brexit
It was uncertain for a very long time, if the British installations would have a compliance obligation in the EU ETS for 2019 and 2020. The issuance of UK allowances (both free allocation and auctioning) has been therefore suspended since 1 January 2019, meaning no UK allowances have been issued since then. The Withdrawal Agreement has been ratified by the UK and the EU in January 2020, the country therefore left the EU on 31 January. From that day until 31 December 2020, there will be a transition period, during which the UK installations have a compliance obligation in the EU ETS meaning that they have to cover their emissions in 2019 and 2020 with EUAs. The country therefore has to issue allowances for these years. While the free allocation of the British allowances started early February already, the auction calendar has been published 21 February only.
Auctions of British allowances restart on Wednesday, 4 March and will take place every second Wednesdays on ICE until 9 December 2020. A total of 123 million allowances will be offered for the two years of 2019 and 2020. The auctions of the other EU member states on EEX will be not affected by the restart of the British auctions. The 5.7 million volume will be halved in August, as usual. According to the calendar, the volumes from September increase to 6.8 million but this will change after the publication of the total number of allowances in circulation (TNAC) by the European Commission in May and the quantity of allowances that will be absorbed by the market stability reserve from September. The transition period ends 31 December 2020, but according to the agreement between the EU and Britain the installations can comply until the end of April 2021. They will not lose their access to their Registry accounts and to their allowances until the end of the next compliance period in April 2021. The UK leaving the EU ETS means that the system will lose an important influencer, as the UK has been always a pioneer of emission reductions and supported ambitious climate goals. On the other hand, as the UK reduced emissions in its power sector faster than expected, many allowances it auctioned in the prior years was absorbed by other market participants than UK power companies. We can say that it contributed to the surplus of allowances in the market in the past, which will not happen in Phase 4.
On the other hand, the UK plans to launch its own emissions trading system soon and the long-term plan is to link the EU ETS with the British system.

Outlook
To comply with the EU ETS Directive, the European member states have to distribute the 2020 free allocation until the end of February. This year, the UK will allocate two years’ allowances. Once the free allocation on their accounts, installations might be less active with EUA purchases and the demand for allowances might decrease. Some installations in a desperate need of cash might even sell (some) of their 2020 allowances. Due to a special point in the regulation, however, we do not expect many companies using their 2020 allowances. While installations can use their free allocation for the current year to comply for the previous year’s emissions within a phase, this opportunity is not available between phases (so called borrowing).
2021 will be the first year
of Phase 4 and the allowances received in February 2021 can be only used to comply for Phase 4 emissions. In April 2021, however, the companies still have to comply for their 2020 emissions, the last year of Phase 3 without having the opportunity of borrowing.
2019 verified emissions have to reported until the end of March and the companies in the ETS have to surrender the equivalent amount of allowances until the end of April.
The faster than expected decarbonisation of the European utilities might result in a significant decline in the emissions. Gas prices fell sharply as supply increased (mainly thanks to LNG deliveries), while demand remained low as reserves are at record levels and 2019 being the second hottest year on record. Other part of the fossil fuel capacities has been replaced by renewables and the coal exit policies of the governments also played an important role in the decarbonisation of the European electricity production.
Industrial installations were also less active in the carbon market last year as the economy slowed down due to the conflict between the US and China that redirected Chinese exports towards Europe reducing domestic industrial emissions.
The price development in the European carbon market will be defined by three major factors in the upcoming months. The first is the compliance period the deadline of which is the last day of April. The results of the UK auctions will also provide a good indication of there is enough demand to absorb a significant quantity of allowances. Last, but not least the coronavirus might overwrite all existing plans, if the authorities are not able to halt the spread of the epidemic.

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