By Mathew Carr
Dec. 3-4, 2020 — LONDON: The strong close for EU carbon futures Wednesday hinted at the potential for allowances to reach a record level very soon indeed, as Germany will probably confirm it’ll cut supply.
December allowances advanced after surging by almost one quarter in November. They advanced above 30 euros Friday and need to print above 31 euros to beat their record.
The region’s biggest economy said this week it plans to close coal-fired stations as it seeks to spur emission cuts. That will ease an oversupply in power markets, allowing electricity prices to advance, but this time it probably wont create a glut in the carbon market.
That’s because the nation has said it’ll cancel some of its portion of EU carbon allowances should it decide to close fossil-fuel stations using policies other than the CO2 market — and it IS using alternatives, auctions of financial support.
See this source document setting out this week’s closures (ask to translate if needed):
And this from February:
There are more closures to come next month.
In July last year, carbon allowances rose to their highest in 11 years after Germany signalled it would cancel to prevent a glut accumulating again in the CO2 market. The program spent most of its first 15 years in a state of surplus.
See this from when I worked at Bloomberg News:
The EU, for its part, has held off finalising the carbon-allowance auction schedule for 2021 for extremely technical reasons. The first sales won’t take place until as late as early February instead of early January, according to this announcement:
It’s also delayed distribution of free allowances until the second quarter at the earliest. They usually get handed out in February.
The delays have lowered supply temporarily and may force compliance buyers to purchase in the futures market to hedge risks.
The options market has already indicated prices could surge this month, with high-level strikes for Dec.-2020 call options enjoying some the biggest levels of open interest, a measure of trading positions that have not closed. Check out the option to buy at 65 euros.
See this snip from the website of ICE Futures Europe’s Dec. 1, 2020 EU-allowance-option report:
Overall, at the end of November, open interest jumped to its highest for two years, signalling that some hedge funds and investors have returned.
See this chart:
Europe is also under huge international political pressure to cut coal emissions because it’s got much of the historical responsibility for climate change and a substantially lower population than China, which is the biggest emitter currently (but with less historical responsibility).
The EU’s Executive Vice-President Frans Timmermans gently criticised China on Nov. 26 in a lecture at Tsinghua University:
“I have huge respect for China’s capabilities and determination. We have seen so much happening, also in the past. And in this context I will also say that the increase in the licensing of new coal power plants-projects over the past year is very worrisome to many Parties of the UNFCCC, including to the EU. It runs against economic sense, and makes all our work more difficult, also that of China.”
China’s threatening stance on new coal may be a negotiation tactic and it’s probably criticizing back, arguing as part of the negotiations leading up to the Glasgow climate talks in a year’s time that it’s for Europe to cut deeply, first.
Both the EU and China are seeking to draw the U.S. into climate protection after Mr Trump’s departure (if he ever leaves).
The EU is also tightening its carbon market stability reserve designed to absorb allowances and it’s considering a much tighter 2030 emissions-reduction target.
See this recent story on the potential for a very tight limit, indeed:
After all that, the EU is now under EVEN MORE pressure from Brexit, with the U.K. proposing an emissions cut of 68% by the end of the decade versus 1990 levels under the UN Paris climate deal. It might mean a faster switch away from natural gas boilers for home heating and more use of international carbon markets, if emerging nations that make up the bulk of the UN agree to rules.
See here: https://carrzee.org/2020/12/03/greta-asked-how-dare-you-britain-now-gets-daring-on-climate/
Now Britain’s move is a much tighter limit than the EU’s current plans for a 55% cut in the same 30-year timeframe and if the union adopts something like it, it means a much lower volume of allowances available for the market.
When supply drops and demand rises, markets usually move only in one direction, even ones as notoriously fickle as this one. (I’ve been wrong before, so don’t hold me to it.)
(Earlier version corrected timing of first 2021 auctions to early February; adds gas boilers near end, open interest total, why a tighter target matters, updates prices Friday, adds open-interest chart, updates U.K. target)