“How ridiculous and how strange to be surprised at anything which happens in life.” (Marcus Aurelius)
Unless you’re an industrial compliance buyer, carbon has had a cracking start to the year. Prices are up 52% from the low of November 2, the date on which this current rally started, and nobody seems ready to call a halt to the proceedings yet.
I'm not sure I expected things to take off quite so explosively, but here we are anyway, setting a new record high on an almost daily basis. Is the sky really the limit now?
I've already written copiously about how all the signs are aligning to point towards higher climate ambition in Europe, how the EU ETS is about to go into the workshop for its (seemingly) annual medical and tune-up, and how uncertainty is currently the new black.
And you probably don’t need me to explain why the market’s rocketing, but I’ll recap in a few bullet points:
1. No auctions till Jan 29th. Not only that, but when auctions do restart, the volume on offer will be significantly lower than it was in 2020. Between January and August the EU, Germany and Poland will sell a total of 408 million EUAs on a pretty much daily basis. That’s 80 million EUAs fewer than were sold in the same period in 2020, or around 2.5 million EUAs a week less.
(We won’t find out the September-December volumes until late May, when the EU confirms the total available supply in the market and does its MSR calculations, so hang tight till then.)
2. No UK supply. The UK was commonly accepted to be a net long member state. The last year that we have reliable same-year data is 2018 (i.e. before the Brexit suspension in 2019 and the double-auctions in 2020). 2018 free allocations were 152 million, while a further 101 million EUAs were sold at auction. Verified emissions came in at 128 million, giving an annual surplus of nearly 125 million. I’m not suggesting that the UK had a net surplus of 128 million in 2020 as well, but it must have been a sizeable number, and something that the wider market would have appreciated around now.
3. No Article 10(c) auction volumes. In 2019 and 2020 Poland sold a total of 113 million EUAs from its Article 10(c) reserve, instead of handing them out to power generators to help with plant modernisation. These sales were one-offs anyway, and won’t happen this year.
4. The Commission has not yet scheduled the sale of EUAs to feed the innovation Fund, so we’re waiting on details and volumes from that.
5. Free allocation of EUAs for 2021 has been delayed until the second quarter. The Commission and member states have only recently completed their work on the benchmarks that will determine the amount of free allocation, and this has to be turned into provisional allocation tables for each member state.
Obviously these delays shouldn’t have an impact on companies’ 2020 compliance plans, since Phase 4 EUAs can’t be used for Phase 3 compliance. Nevertheless the delay should be adding to the general feeling of tightness in the market. And with prices seemingly headed skywards, some industrials might be getting concerned about their 2021 compliance costs already.
6. Colder weather in Europe is driving increased power demand. For example, French regulators have already had to ask consumers to be a little less profligate with their heating as demand is straining the grid. That in turn has led to more coal burn and more prompt demand for EUAs to cover the additional CO2 emissions.
7. Equities markets are setting record highs, and that’s feeding into the overall sentiment.
8. The start of a new year usually brings additional strategic and speculative investment into the market. Given how far prices have risen in the last two months, there should in all likelihood be plenty more money looking for a strong return.
What’s interesting about this rally is that for almost the entire time, news on Covid-19 has been pretty gloomy. Yet equities and energy are disregarding any likely economic impact of tighter restrictions on movement and indeed lockdowns such as the one in the UK. I find that a little curious, but perhaps the lesson of 2020 is that economies kept spinning despite the measures.
With a vaccine gradually working its way into the population, perhaps we can look forward to a relaxation of the restrictions and a return to, if not exactly "normal", then the "normal" we experienced last summer. I certainly haven't heard anyone talking about a return to pre-Covid days – yet.
And really, at this moment it seems as though the only bearish potential lies in weather and Covid. Everything is very short-term at the moment: the most important weather forecasts seem to be those that look at next week rather than next month, and price expectations tend to be rooted firmly in the prompt rather than the long term.
Most traders I’ve spoken to are waiting for the resumption of auctions at the end of January when, you could argue, the resumption of supply should relax the perceived market tightness. Between now and then, they say, there may be the occasional bout of profit-taking, but on the surface of it there seems to be very little to interrupt the market’s march higher - at the moment.
This is borne out to some extent by the #EUAPredict contest that I'm holding on Twitter. Entries closed earlier today and generated an average forecast of just over €40/tonne for the settlement price at the expiration of the December 2021 futures contract. Between now and then, quite a few people have suggested, prices could go even higher.
But before we get excited about December, history shows us that January is a pretty volatile month. The chart below shows every January price series since 2008, indexed to the first settlement price of the month. Of the last five years, only 2018 saw a January in which prices ended the month higher than where they began it.
Caveat emptor.