• Alessandro Vitelli

All change?

The worm is turning. European power economics are shifting in favour of coal, especially at the front of the curve, and this might be seen as being supportive of carbon. If coal’s more profitable than gas, then surely there should be more demand for carbon, right?


Well, yes. And no. Anecdotal evidence suggests that near-term coal margins are getting close to those for gas, but it’s not the same picture all along the curve. So we need to be a little bit careful here.

Firstly, the chart below shows what gas has been doing. The chart shows an index for front-month, front-quarter and year-ahead TTF prices this year. The big break came when Q4 became the front quarter, bringing the winter season into view. While month-ahead prices were slow to follow, they started catching up pretty quickly when October became the near month, and they’ve been closing the gap ever since.

Note, however, how the front-year TTF has been stubbornly refusing to get caught up in the excitement of reduced US shale output and soaring Asian LNG prices. TTF prices for cal-21 are *still* below where they started the year.

The last few days show the rally tailing off, but the same is true for coal (see below).


Now, on to coal, where we have a broadly similar picture, in which the front-month and quarter prices are well up on the year, no doubt pushed up by sellers eyeing EU power economics. Yet, same as for gas, the cal-21 is refusing to catch up to its January 1 levels.


So that leaves us with month/quarter/year-ahead clean spark spreads that look like this:



…and month/quarter/year-ahead clean dark spreads that look like this:



Put them together and you get a set of climate spreads that are headed towards flat. Gas’ advantage has been all but completely eroded.

To be clear, cal-21 gas-fired power is still €2.30/MWh better off than coal (other spread calculations are available; contact your nearest utility for more information), but, with a couple of exceptions this is the narrowest it’s been all year.


But why is it lagging?


The obvious suggestion is that most utilities have more or less done all their 2021 baseload hedging by now, so respective coal and gas margins are locked in and there’s little left to do.


Of course that leaves the portion of generation that is dedicated to prompt demand, and that’s where the real spread-shifting action is happening.

The other is that there’s no real sign that Covid is going away, and the outlook for cal 2021 is, as things stand, pretty similar to 2020. Total EU power generation is down more than 5% in 2020 from last year, according to the Wartsila Energy Transition Lab, and it will be interesting to see how January and February 2021 stack up to this year’s numbers.


So the very short term looks a (very) little bullish for carbon, driven mainly by seasonal considerations, but the next couple of months are slightly less rosy. So let’s look beyond into 2021.


2021 brings with it the start of EU ETS Phase 4 and a whole new set of rules and circumstances. Let’s review one more time:


1. The linear reduction factor (the annual reduction in the overall cap) goes from 1.74% to 2.2%. That’s means roughly 38 million EUAs a year will be taken out of the market, according to some calculations.

2. The UK leaves the EU ETS. Well, we don’t know for certain, but come on, what are the chances of the UK staying in? Zero? Less than zero?

The UK represented an annual net surplus of about 125 million EUAs in 2017 and 2018 for the rest of the EU ETS, and Lord knows what it’ll be this year since Britain has auctioned off two years’ worth of allowances….


3. Covid-19. ‘Nuff said.


4. Poland won’t be selling any EUAs from its Article 10(c) reserve in 2021: that’s about 110 million or so fewer EUAs in the market compared to 2019 and 2020. Under Article 10(c) ten member states were able to allocate free EUAs to power plants, in exchange for investments in reducing CO2 emissions. Poland withdrew from 10(c) in 2019 and 2020, and instead sold those EUAs into the market.


5. The EU’s 2030 target and the Green Deal. Everyone is bullish on these reforms, but we’ve yet to see any real numbers. Nonetheless, climate ambition is a buy.


At the Carbon Forward event earlier this month, four out of five analysts predicted EUA prices would average around €35/t in 2021 as the sheer weight of bullish regulatory developments forced the market higher.

Another interesting element comes from the EU’s new Hydrogen Strategy, which suggests that in order to achieve green hydrogen production of 10 million tonnes by 2030, we’ll need an EUA price close to €90 by that time to make zero-carbon hydrogen competitive with fossil fuel-based H2.

Taking this one step further, BNP’s Mark Lewis discounts that €90-ish 2030 price back to today and calculates that the value of EUAs should be around €50 right now, in order to develop the right price signal by the end of the decade.


So the autumn weakness that people were forecasting back in April and May may just about have run its course. Barring some really bad Covid developments, we could be turning a corner where the sheer scale of Europe's climate-political ambition begins to outweigh the rather poor real-time data.


Today's (October 29) market was a case in point. Around 10:30 London time the EU announced it has opened the consultation on its inception impact assessment for the 2030 target review. We've known for quite a long time that the reforms will include an assessment of the MSR's performance, and may enact changes to its parameters.

Despite the relative lack of newsworthiness, the news was flashed by the agencies and EUA prices duly jumped €0.40 and reversed the bearish trend.


What this suggests is that the market is more than ready for bullish input. Analysts have been forecasting it, investors have been preparing for it, and now the market is becoming impatient to start pricing it in.