(This blog was originally published on Carbon Pulse on 28 June.)
Despite a three-week-long rally that has added more than 12% to EUA prices, carbon needs to rise even higher in order to restore natural gas’ advantage over coal in power generation, updated data show.
Natural gas prices have been gaining rapidly as tight supplies in Europe and declining coal generation have prevented the region from restocking after an extended winter. Stiff competition for LNG cargoes from Asian buyers have contributed to the rise.
Calendar 2022 TTF gas futures on Ice Endex have risen by 26% in the last month, compared to an increase of 19% for calendar 2022 German baseload power and 14% for December 2021 EUAs.
Gas has outperformed all other major energy markets in Europe over the past month, and is now the second-best performer over the course of 2021, as the chart below shows.
Source: ICE Endex, ICE Futures Europe, EEX
The combination of recent price moves has narrowed the year-ahead German clean-spark spread, the operating margin for power plants that will use the fuel to generate power next year, from around €2.70/MWh in mid-June to break-even levels today.
Over the same period the year-ahead margin for coal-fired plants, known as the clean-dark spread, has improved from a loss of €7/MWh to a loss of around €4.70/MWh for German utilities (the calculation assumes a coal plant thermal efficiency of 38% and a gas plant efficiency of 50%).
Separate calculations show that the price of carbon required to maintain the competitive advantage of a 54% thermal efficiency gas plant over a 42% efficient coal plant has risen from €32.90/tonne one month ago to €48.90/tonne today.
The chart below shows the carbon price required to keep gas plants of varying thermal efficiency competitive against coal plants.
Source: ICE Endex, ICE Futures Europe, EEX
While the actual price of EUAs remains well above the most competitive fuel switching price, its premium to the fuel-switching level has narrowed by around 50% in the last month.
For month-ahead power, the picture is totally different. The current fuel switching price for 42% coal to 54% gas has now flipped back in favour of coal, as the chart below shows.
Carbon’s current discount to the most competitive fuel switching price is now €12.
The increase in the fuel switching price chiefly reflects the rapid rise in gas prices. Lower than normal gas flows from Russia to Europe through Ukraine have exacerbated low storage levels, while the transition away from coal-fired power to gas has meant that the extended winter helped to deplete levels below seasonal norms.
Despite accelerating prices Europe is struggling to replenish its gas stocks. According to data from Gas Infrastructure Europe, total gas in storage is near its lowest level for the time of year since 2015, and the rising price trend shows little sign of slowing down at the moment. Month-ahead natural TTF gas prices have risen more than 22% in the last month alone, and have more than doubled since the start of the year.
Spurred by these gains, carbon has shrugged off the impact of range-bound options-driven trading in the run-up to the June contract expiry and posted six successive days of higher lows and higher highs on its way to a peak of €55.82/t earlier on Friday.
However, the recent gains have not been enough and either carbon will need to increase further or gas will need to fall back in order to re-establish the historical trend, and gas’ pole position in the power merit order.