May you live in interesting times
Well, this has been an interesting week. In the space of 72 hours carbon has risen 14%, reached a new all-time record and if things keep going like they have been, it’s just a matter of time before the EUETS starts becoming the subject of $GME-type memes.
There have been a number of explanations for the nearly €5 spike in EUA prices; I’ll list them and if I missed any, please shout.
1. Media cheerleading. Successive articles on Tuesday (Bloomberg) and Wednesday (FT’s Lex column) wrote at some length about expectations for EUA prices to reach €100 either this year, or by 2030.
It’s become a running joke in the market that whenever these high-profile bullish articles appear, the market invariably reacts. Check out the piece that Mike Szabo and I wrote last year about this.
However, bear in mind that these articles are increasingly backed up by sector analysts.
Lawson Steele at Berenberg Bank talked in 2019 and 2020 about short-to-medium term prices reaching €100 and higher, though his current outlook peaks somewhere lower than that. Over at BNP Paribas, Mark Lewis has written at length about how green hydrogen needs a price of above €90/tonne by 2030, and he works backwards from that number and date to peg the fair value of carbon somewhere around €50 this year.
Equally, the team at Refinitiv last October predicted prices would top €80 by around 2029, and even BNEF sees €75 by the end of the decade.
So when Bloomberg and the FT write about €100 prices for carbon, it’s not completely wild. It might not happen today, but then the analysts that participated at the Carbon Forward conference last October were mostly seeing €35 this year. We’re already there after just four weeks….
2. Speculative inflow. Some of the price action over the last two days has seemed to suggest that new entrants are happy to acquire length at any price. There have been moments when big buy orders have moved the market as much as €0.20 in a minute, as buyers sweep the offers, and it’s also clear that sellers are becoming more and more cagey.
ICE Commitment of Trader data shows that over the last few weeks the numbers of investment funds and miscellaneous financial institutions with positions in EUAs have risen to their highest-ever levels, which does back up the new money theory.
One data point that doesn’t necessarily help is open interest. You’d think that new positions would add to open interest, yet the Dec 21 OI has steadily decreased since it took over as the front-Dec contract in mid-December last year.
Of course, it’s also possible that this length could immediately be turned into a spread position against Dec 2022 or later, and the Dec 22 OI in particular has risen steadily.
3. Short covering. As prices started to move sideways in the second half of January, after rising steadily for more than two months, the opportunity to put on a short was probably too good to resist. Even on Monday it still seemed like a pretty good trade.
But the early market moves on Tuesday may have triggered covering for some stops that were set at moving averages. Note how the Dec 21 contract crossed both the 20-day and 30-day MAs pretty early on Tuesday, and this may have set off the first rush of covering.
Obviously a healthy portion of the volume on Tuesday would have been covering shorts, but by Wednesday you’d have to believe the activity had shifted into adding new longs, or adding to existing length.
4. The rapid price rise will also have triggered some delta hedging. As of the close on Tuesday there was something like 25m tonnes of call option OI at strikes from €34 to €38, and while a fair bit of this exposure will already have been covered, it's safe to say that as prices climbed, particularly today, traders were also covering some of the 40m tonnes of call OI at strikes from €39 to €42.
5. Policy? The overall macro mood in climate has been improved markedly by Joe Biden’s accession to the White House, even if the chances of a US federal carbon price still aren’t great. And China’s launch of its nationwide “ETS” (you know, the kind that doesn’t have a cap) is another step in the right direction.
If you read through the media you’ll see that there is a sizeable number of countries studying emissions trading: it’s a case of “watch this space”.
All of that doesn’t change the price of an EUA, but it validates the concept and the attraction to potential investors. This is the spark that leads to a feasibility study, that leads to some meetings, that leads to someone buying several million EUAs. Of course, they could have avoided all that work by just reading the FT, right?
And it’s not just institutional either; there are retail investors out there who have been reading the same articles on Bloomberg and the FT and who are looking to participate in carbon markets.
So we're left with the EU's policy on the EU ETS, which I’ve already written about here. And nothing much has changed since the Council agreed to the 55% target back in December. But it’s there, in the background, and it feeds into the market through things like analysts’ predictions.