This week’s outlook for the EU ETS is bullish to neutral – just about anything could happen with EUAs trading at unprecedented levels and the Dec21 options contract expiring this Wednesday the 15th. The Dec21 options contract shows significant volumes of open interest for €80 and €100 strike call options, while the market has been trading choppily, potentially as traders hedge their options ahead of Wednesday. There is a chance the market will be sucked either to €100 or €80 by options traders. On a similar note, inflation looks likely to attract participants to the market.
The absence of options hedgers after Wednesday could give way to better EUA prices as EUAs are at exceptionally high levels now – so gains may be limited given there is downside risk after Wednesday, and the market clearly can lose 10 euros in a day without trouble.
Yet fundamentals may be strengthening for the EU ETS. The market is being driven largely by the inability to switch electricity generation from coal to gas – which has left the market mostly unable to eliminate emissions in sufficient quantity in the short term and vulnerable to price spikes. Current EUA price levels are being set by future dated anticipated emissions reductions due to fuel switching, and as those prices get worse, so does the bullish case for EUAs – potentially leaving us chasing the fuel switching price at €300. Colder weather and a pause to EUA auctioning over Christmas should lend support to the market, while doubts over the certification of Nord Stream 2 are the drivers of this worse outlook for fuel switching – also placing the risk to the upside. Finally, The Polish and Czech governments are leading calls for market intervention to reduce carbon prices, which could impact enthusiasm for EUAs at these prices.
EU ETS Outlook: bullish to neutral
YTD Average Price: €52.13 Indicative EUA Price: €84.00
- Wintery weather, strong clean dark spreads, no EUA auctions over Christmas and low wind power support fundamental demand: coal is all but locked in for winter and low Central European wind levels send a further bullish signal to the market.
- Options contract expiry on Wednesday to prompt volatility: the market should be drawn towards key levels for options calls with strong open interest – traders are unlikely to let it drop substantially away from their strike prices.
- Market is short, no short term abatement means prices are being set by emissions reductions along the curve: ICIS estimate the market is short by 150 million tonnes of CO2 in 2021. Except for industrial shutdowns and renewable generation, there is no ability to reduce emissions in the short term given that fuel switching from coal to gas is currently impossible – therefore the market is prone to spikes. The April TTF Gas contract, which has been trading around €50, is now at €84 – a sharp increase exceeding price gains on the front end January 2022 TTF gas contract and possibly a clue to rising EUA prices as abatement of emissions looks less and less likely in coming months.
- Nord Stream 2 delays could keep market rising, though there is some disagreement on gas flow resumption for 2022: comments from the German and US governments on Nord Stream 2 certification raise doubts as to how fast the pipeline might be approved – if at all, in the event of open aggression in Ukraine. This could be interpreted as an insurmountable obstacle, though a pragmatic view has it that gas flows will improve in Q1 as that is in the interests of all parties and existing pipelines are still able to supply adequate gas volumes. At present, the market seems to believe that gas flows will not receive a boost any time soon.
- Demand destruction, conservation of gas supplies to prevent EUAs from going all the way to €300: Bloomberg reported last week that industry may be asked to shut down to prevent gas shortages from hitting domestic heating. Such intervention, plus voluntary actions by industry – and a reluctance to buy EUAs themselves at high levels, in the hope EUA prices will drop, will most likely ultimately prevent the worst of scenarios coming to pass. ICIS analysts also point out that there are other industrial technical adjustments achievable that can yield emissions reductions at prices under €90 per EUA.
- Minimal industry interest in EUAs @ €80+, distribution of remaining free allocation could soothe EUA prices: at this point not many industrials are showing much interest in buying EUAs at these high prices, especially given expectations for lower prices after winter next year. Some companies may be forced to buy in Q1 next year, though they may choose to use their 2021 and 2022 free allocation of EUAs to avoid the high prices.
- Inflation keeps risk to the upside: below are plotted EU inflation rates for 2021 against EUA prices. Those looking to place their money in an asset could be attracted to the EU ETS, especially given the growing number of funds offering access to both institutional and retail investors.
- Poland and Czechia lead calls for injection of EUA supply: the Polish government are threatening to withdraw from the EU ETS – though not a simple thing to do in practice given that Poland receives substantial EU funding. The Czech Energy Minister Karel Havlíček is quoted in Euractiv saying that around half of EU member states advocate adding 400 million EUAs into the EU ETS to calm prices. Though unlikely to trouble the market this week, calls for intervention are something to look out for in future months.
- Technical analysis: the market is no longer overbought after last week’s correction, according to the Relative Strength Indicator (RSI). The correction has current prices looking more sustainable, with trend support at €80.80. The round numbers at €80 and €100 are most likely the key levels to look out for this week, recent price developments suggesting €80 is more likely than €100. The next level of resistance of note is €88.60 while to the downside failure to stay above €83.89 will suggest further losses are in store.
See also our UK ETS market update here