The Great Covid Sell-Off is over. Now it’s the Great Covid Rally. EUAs are now back where they were in the middle of February, and all that is left of the pandemic’s impact on the EU ETS is a slightly V-shaped price chart.
Here’s the picture as of May 23. Year-ahead carbon and power are the only energy markets that are above their pre-sell-off levels (which I start at March 5):
While power’s making a nice recovery, coal never really suffered at all anyway, and Brent and gas are slowly but steadily closing the gap.
And the question that keeps coming up is “why?”. Has anything really changed in the last month? Are we *really* coming out of lockdown? Is the economy really back to where it was in February/March?
Of course not. We’ve lost 90 days of full-steam-ahead activity that can never be recovered. Emissions will fall by something like 200 million tonnes in 2020. The market already has 1.385 surplus billion EUAs swimming around.
Power generation this year in the EU is currently down by around 6% year-on-year – while renewables’ share of the total is up by nearly 12% from 2019, according to ENTSO-E data. EU industrial output was down by 2.1% in January, 2.2% in February, 13.5% in March and 28% in April compared with a year earlier.
Back in the good old days, people used to watch the clean-dark and clean-spark spreads too. But there’s little point in that today, since the dark spreads are nowhere while the spark spreads are heading for the skies. Look at the climate spreads for the front month/quarter/year and you see just how bad things are for coal.
And, back in those good old days, plant economics like this would be bearish for carbon.
You know it. The analysts know it. Even *I* know it. This market is oversupplied.
And yet EUAs rose to a four-month high of €25.50 today.
So. If we assume that for the moment anyway, fundamentals mean nothing, then what’s going on with EUAs?
Two or three weeks ago, everyone was talking about carbon’s correlation to equities. Equities were climbing as governments poured more money into the system, and people had to do something with all that free cash. Carbon seemed to be tagging along.
But while equities started to level off in the past week, EUAs just kept on rising. No matter what time period you use to measure correlation, the link is falling away.
And instead, what has started coming back to life is the carbon-energy correlation. After CO2 disconnected completely from gas and coal at the start of the month when they were getting close and personal with equities, things appear to be reverting to normal:
At this point I should talk about technicals, because everyone else is. For the last two weeks and more, the 200-day moving average was the main focus of attention. EUAs tested this average four times before finally breaking above on June 18.
And since there were clearly a lot of short positions also pegged to the 200-day, the breach triggered a wave of covering, which drove prices well above €24.00.
Since then the momentum has been sustained and has even increased as long positions eye the next targets: the respective February and January highs of €25.86 and €25.90. After that, it’s the €27.14 from December and then the €27.56 from September.
And once you get there, it’s no great leap of imagination to start thinking about €30.
If you’re a chartist you’ll probably know already that last Thursday’s spike crossed the 618% Fibonacci retracement of the decline from last July (€30.34) to March (€14.34). That’s a nice, nearby support too.
Those are the points of interest for the bulls and the technicians. I would add however, that if this rally does run out of steam and turns into a rout, there is a significant level that would be worth watching for. It intersects neatly with the area around €14.34 that we explored earlier this year.
I’ve drawn a rough trend-line that dates to the period from 2013 to 2016 – that is, before the market gave its verdict on backloading and then started to price in the MSR. This weekly chart shows that trend line intersecting with the area around €14.34, as well as the 200-week moving average. Today, that intersection is based roughly between €15.00-15.75.
So if we do ever return to fundamentals – and we will at some point – that could be a fair value given the state of the market balance.