CO2 market

The carbon market got under pressure in October

0
80

by Bernadett Papp

The benchmark carbon contract lost 7.5% from the end of September until 24 October.

Auction results were generally weaker than end of summer as the volume offered was higher and the temperatures remained several degrees above the seasonal average in Europe.

The carbon market experienced its biggest intraday volatility of 2.19 euro on 15 October, after the publication of a technical note by the UK’s Department for Business, Energy and Industrial Strategy. The paper called traders’ attention on the fact that British and European negotiators are running out of time to reach an agreement about the terms of separation. The benchmark carbon contract plummeted by 8.8% on that day only.

Beside the hardly forecastable selling of speculators, hard Brexit is the second biggest risk to the increasing trend of the carbon price at the moment.

If there is no deal, there will be a full rupture from 30 March 2019 without any free movement of goods, services, capital and people and therefore no EU ETS membership.

The UK has four options to put a price on its emissions after its separation from Europe:

1.   It can stay in the EU ETS, if there is a soft Brexit and the terms of separation and future relationship with the EU allow for this solution. This is the most “comfortable” option, as installations would not face any regulatory uncertainty. They would receive their free allocation as they used in the past. UK auctions would be successful as the allowances would be eligible in the system. This would be a similar approach to Norway, Iceland and Lichtenstein who all participate in the market but are not members of the EU. The UK expressed its wish for a 21-month transition period from April 2019 in case it can reach an agreement with the EU that is accepted in the UK Parliament as well.  In March 2018 the UK confirmed that it would like to remain in the EU ETS until at least the end of phase 3 in 2020 (31 December 2020). The continuation of the EU ETS membership is also supported by key business players in the UK as they want to avoid any uncertainty regarding their compliance obligation. The signatories of a statement in September (EDF, Unilever, WindEurope) are mainly multinational companies that have operations in many European countries and prefer being subject to one system to having a compliance obligation in multiple systems.

2.   After 2020 or in the case of a hard Brexit, the country could create its own emissions trading system as the infrastructure for monitoring, verifying and reporting emissions, surrendering units is available. In this case, there are two options (also depending on the overall Brexit deal): the UK can either link its standalone ETS to the EU system or not. The first option would eliminate the uncertainty regarding the eligibility of allowances issued by the UK after Brexit.

3.   Last, but not least, the UK could consider extending its current carbon price support to other sectors. Since 2013, British utilities pay a tax on top of the price of EUAs, which could be applied to other polluting sectors as well.

A soft Brexit would leave enough time for British compliance entities (both stationary installations and aircraft operators) to prepare for an orderly exit. The more time installations have to prepare themselves for the exit, the less the shock they can cause in the carbon market with dumping excess allowances. British utilities on the other hand might slow down their hedging activity as soon as they see clearly until when they have a compliance obligation. This might have a slight bearish effect on the carbon price. Overall, however, a soft Brexit would only cause a limited negative effect on the carbon price.

The most important question is what happens to these allowances in the future.

If the allowances are eligible in the future (because the UK stays in the EU ETS or because the UK ETS makes EUAs eligible), the installations will stick to their allowances.

If the EUAs are no longer eligible, the allowances will be mainly sold in the market. Here a lot depends on when the installations receive information about the future ineligibility of EUAs. If they have enough time to monetize the allowances, they won’t sell them all in the market in one go to not depress the price. In the case of short notice, the price effect will be more dramatic, of course.

For multinational companies there is also a chance not to sell the allowances, but to transfer the surplus allowances to their sister companies in continental Europe for future use. This could have a bearish effect on the carbon price, either because of the sell-off of allowances or due to the lower demand of European sister companies.

Depending on the overall agreement between the EU and the UK about the free movement of goods, services, capital and people, there might be also an opportunity for UK installations to open a registry account in another EU country and transfer the allowances.

Although many question remain open, the 2018 compliance is quite clear already.

The government has taken steps to provide certainty to UK operators in meeting their compliance obligations for the 2018 compliance year. To ensure this will not be affected in a ‘no deal’ scenario, the government brought forward the 2018 compliance year deadline in domestic legislation for operators to report their 2018 emissions and surrender allowances for those emissions from 30 March 2019 and 30 April 2019, to 11 March 2019 and 15 March 2019 respectively.

The 2019 free allocation is still uncertain, but the recently published technical note on the no deal Brexit specifies that «any EU Emissions Trading System allowances issued by the UK for the 2019 compliance year cannot be used by UK operators to meet their 2018 compliance obligations. Operators will want to consider this when planning to meet their 2018 compliance obligations».

November might be the last month for negotiators to close a deal, because the agreement has to be ratified by the British and the EU parliaments. Market participants will watch therefore very carefully all the announcements from London and Brussels.

On the other hand, fundamentals might act in the opposite direction compared to October. The auction supply decreases as the extra volume from cancelled auctions in September will be sold by then and there won’t be any auction on Fridays from the second half of the month, as the contract between Germany and EEX exchange expires. (German auctions are expected to resume in the first quarter of 2019). In addition, temperatures are expected to return to the seasonal average in November, increasing the demand of heating companies.

LEAVE A REPLY

Please enter your comment!
Please enter your name here