Has EU carbon rounded the corner?
We are now in the last four weeks of the Dec 20’s reign as the front-year futures contract. There are fewer than 25 daily auctions left this year, and today (Nov 17) we have been told that the European Commission won’t be starting 2021 EUA auctions until the end of January or even early February.
On top of that, Poland has not yet signed a new contract with EEX, the exchange that will handle most EUA auctions from next year (the UK is likely to have to continue selling EUAs to Northern Irish power generators that are still covered by the island's single electricity market). The last time Poland needed to re-up with EEX, it took seven months to complete the agreement.
There’s also a question mark hanging over the free allocation of EUAs to industrial installations for 2021. While the Commission hasn’t said anything official, member states are still knee-deep in the process of approving new benchmarks that will set the bar for that allocation, so it’s not certain that this process will be done in time for EUAs to be sent to member states in February.
That leaves us with a period of at least seven weeks in which there will be no EUA auction supply. And even if EU-25 and German auctions do resume in the first week of February, we won’t have any Polish volumes for…. well, based on previous evidence I’d count in months, rather than weeks.
One analyst earlier today suggested EUA prices could end the year at just over €30, and based on the news from the Commission, it’s hard to dispute that.
All of this is before we even start to consider the changes to the supply/demand balance for 2021. A steeper linear reduction factor (2.2% compared to 1.7% in Phase 3), smaller allocation of free EUAs to those sectors not deemed to be at risk of carbon leakage, and an MSR withdrawal that may well be the highest we’ve seen yet.
Because we do not yet know what the auction volume will be, it’s hard to estimate just how many EUAs will be held back due to the auction delay. 2020 auctions were boosted by at least 150m tonnes due to the UK's delayed 2019 volumes and Poland's sale of 50m Article 10(c) EUAs, so we'd have to start estimating from a starting point of around 600m EUAs. But by the time you read this I'm sure analysts will have come out with a proper estimate of supply impact.
At the same time, the bullish policy outlook that has been promised for many months finally starts to peer over the horizon. We may not see anything concrete (i.e. legislative proposals) until June next year, but we should get at least one key signal in the next couple of months.
The European Council has been expected to agree in December on a 2030 EU ETS target as its part of the legislative process. However, recent disputes over the EU budget may mean that approval is postponed into the new year. Though while EU leaders will be focusing on the budget in the short term and will hopefully come to an agreement shortly into the new year, a 2030 decision should follow quickly.
All of which should give some political weight to the market’s generally optimistic outlook for 2021. Remember that at the Carbon Forward event in October, most analysts' predictions for 2021 EUA prices were around the €35 mark.
There’s also a little adjustment that could make life interesting for airlines. Starting in Phase 4, stationary installations in the ETS will be able to use EU Aviation Allowances for compliance. This means that at this time next year, industrials will be able to buy EUAAs as well as EUAs to surrender to the Commission.
While that’s a long way away, I’m pretty confident right now (2130 GMT on November 17) that the differential between EUA and EUAA prices will disappear fairly quickly. That spread is currently €0.30, and was as much as €3.25 earlier this year.
It could work out as a pretty good deal for airlines who might want to cash in any length in their EUAA portfolios, and of course it means that those EUAA auctions will be pretty closely watched from now on. Expect to see an appropriate adjustment to your Ryanair ticket price.
It also begs a question for the European Commission: why bother actually having EUAAs in Phase 4? If they are about to become totally fungible across all sectors of the market, why do we even need them?