We have a bullish view this week. EUAs are set to remain squeezed up to higher prices, in spite of a substantial drop in the TTF gas price. Gas prices have taken a large dip to ±€70 from the +€120 level they hit in the run up to Christmas. LNG shipments arrive to Europe by sea and gas storage volumes recovered slightly over the Christmas-New Year’s period, prompting the drop. Gas prices have, however, not hit the level at which gas fired power generation runs more cheaply than coal fired power, even looking at summer prices – meaning emissions stay high and EUA demand from the energy sector stays strong, while there is no new EUA supply, with no auctions scheduled until the 10th of January. Improved levels of wind to start the week, however, could limit gains, at least until colder weather sets in later in the week. We expect continued low holiday trading volumes, a lack of industry interest and speculator and utility dominated trading will keep the market prone to fairly large swings in price, but with the risk to the upside. Below we discuss the outlook for natural gas as it stands now, the Nord Stream 2 pipeline, and what LNG deliveries by sea could mean for EUAs in 2022, as well as prospects for compliance season ahead of the April deadline and overall supply vs. demand for 2022.
EU ETS Outlook: bullish-neutral
2021 Average Price: €52.80 Indicative EUA Price: €82.00
LNG supplies, increase to storage volumes over holidays depress gas prices, but not enough to favour natural gas fired electricity over coal fired power: LNG tankers are heading to Europe as the high gas price has made Europe an attractive destination for gas supplies. This, and unseasonably mild weather to start 2022, is sending a bearish signal to the gas market in spite of continued eastward flows of gas for the Yamal pipeline.
To materially impact the EU ETS, however, we need to see prices around 40 euros per MWh, running along the forward curve – prices around those levels would allow for fuel switching from coal fired electricity to natural gas fired electricity. Note on the chart above that 2023 gas prices do allow for fuel switching – so we will be watching what happens with further dated contracts for natural gas to assess whether further upside is to come – or whether EUAs could drop back to the 60 Euro level.
Nord Stream 2 remains under a legal cloud: the pipeline has been fully supplied with natural gas by Russia – but doubts have been raised about the viability of approving it. Approval under the EU’s third energy package requires the owner of the transported gas (Gazprom) from owning more than half of the gas pipeline transporting its gas. As yet, Gazprom have been unable to show European courts that they would meet this standard. Compounding difficulties of selling a partial stake in the pipeline is potential exposure to US sanctions – putting potential partners at risk and dissuading them from entering into any agreement. Therefore, the solution may have to be claiming that Nord Stream 2 AG is an ‘independent company’ – which could easily result in rejection by the EU even if the German regulator agrees to go ahead, given the interest of other EU member states like Poland in protecting their own gas sector competitiveness.
More gas supply means business as usual – demand destruction less likely, EUAs supported: the unfortunate consequence of added gas supplies by ship, if they do not send gas prices back to the fuel switching price, is it likely means continued steady demand, no significant demand destruction, and no enforced shutdowns to conserve gas supplies – therefore EUA demand remains at usual levels. At present gas prices remain elevated above the fuel switching price through to 2023, when the market assumes there will be some resolution to the gas crisis.
Thin traded volumes make market prone to outsized moves as speculators and utilities dominate: speculator activity in the market has become a hot topic with the Polish Prime Minister writing in Euractiv that controls must be implemented. France, meanwhile, has advocated for short term EUA price controls – and holds the EU Presidency for the first half of 2022. Until any changes are announced however, speculators look likely to take part in the market – we look for signs of profit taking that could lead to another price dip with the March futures expiry a potential source of reductions, at present wider markets continue to send a bullish signal.
Utilities on the other hand, will need to keep buying – strong German wind generation to start the week is displacing some fossil fuel generation – so we may see relatively lower emissions this week, albeit against a backdrop of no EUA supply via auction.
Colder weather expected: the New Year saw record breaking high temperatures for early January. Those are unlikely to last, with colder weather likely on the way, adding to heating demand.
Compliance period to bring more industrial buyers out? It remains to be seen whether heavy industry will take part in EUA trading again, with few buyers interested at prices over €70. It seems likely that many will use their free allocation of EUAs to cover their 2021 requirements, while a good many hedged their exposure throughout 2021. We may see some buying activity, but nothing that is likely to be of note – industrial last minute compliance buying tends not to have a material impact on the EUA price in the run-up to April as shown below.
Looser market from September: the market’s unprecedented tightness in 2021 will give way to a less aggressive Market Stability Reserve for 2022. Until then, the market remains tight as it was last Autumn. More on that in our monthly reports, available to subscribers.
See also our UK ETS market update here