EU Market: Prices hit 7-wk high but next move uncertain as bullish, bearish factors collide

Published 16:23 on October 9, 2015  /  Last updated at 14:49 on October 12, 2015  /  EMEA, EU ETS  /  No Comments

European carbon soared to a seven-week high on Friday, bolstered first by a strong German auction, then by short-covering as prices breached a key technical level that had capped the front-year futures since mid-September.

(Updates with market close)

European carbon soared to a seven-week high on Friday, bolstered first by a strong German auction, then by short-covering as prices breached a key technical level that had capped the front-year futures since mid-September.

The Dec-15 EU Allowances trading on ICE Futures Europe ended at €8.37 after rising as high as €8.38, the highest since Aug. 20 and marking a 25-cent or 3.1% gain on Thursday’s settlement.

Volume was robust with more than 15 million units changing hands on the benchmark futures.

Prices jumped to €8.21 immediately following the weekly German EUA auction, which saw the country sell 3.198 million spot units for €8.16 each on Friday morning.

That was a cent above the Dec-15 futures and 3 cents above the secondary spot market at the time the sale ended.

The auction received bids for 12.6 million units to give a bid-to-cover ratio of 3.65, which was higher than the year-to-date average of 3.11 but below Thursday’s two-week high of 4.13.

“The auction was surprising. It feels like someone had a big client order to fill and they just came in and bought loads,” one trader said.

The Dec-15s then oscillated between €8.20 and €8.22 over the next hour or so before a rush of buying of more than 1.3 million units within a few minutes vaulted prices over €8.25.

That, several traders said, triggered some automatic stops and manual short-covering, which pushed prices up to €8.32 peak – a cent below the benchmark contract’s upper Bollinger Band.

The Dec-15s then broke above that barrier in late afternoon trade, ending within view of their 2015 high of €8.43 touched on Aug. 20.

BEARISH SENTIMENT

Increasingly bearish sentiment, along with the Dec-15 contract’s failed attempt to break above €8.27 on Wednesday, had prompted some speculators to bet that prices would fall, participants said.

“I saw a lot of volumes on the offer during the week, so most likely a lot of traders were short,” another trader said.

EUA prices had tried to penetrate the €8.24-8.27 level seven times since Sep. 15.

The first trader noted that macroeconomic concerns had increased the credit default swaps (CDS) for major European industrial manufacturers such as ArcelorMittal and ThyssenKrupp.

According to financial information firm Markit, corporate credit risk in Europe has surged in the past few weeks due to declining commodity markets, slowing growth in China, and concerns that the Volkswagen emissions scandal will spread to other parts of the European automotive industry.

Poorer credit health amongst the EU’s top industrial emitters would deliver a “double-whammy” to EUA prices, firstly because it could mean the companies in question will emit less due to lower production, and secondly because it could spur them to monetise spare EUAs if borrowing costs rise.

“EUAs are the perfect hedge for an underperforming business,” the trader added.

Separately, German factory orders unexpectedly fell in August, according to data released earlier this week, another sign that European economies are showing vulnerability to weaker growth in China and elsewhere.

Meanwhile, a British newspaper on Tuesday reported that the UK could force all of its coal-fired power plants to close by 2023 unless they convert to cleaner alternative fuels such as biomass or fit CCS equipment.

Longer term, analysts have also said that falling gas prices relative to coal over the next one or two years could restrict somewhat the anticipated rise in EUA prices.

BULLISH DYNAMICS

But in contrast to the bearish macroeconomic sentiment, market participants highlighted several bullish factors for EU carbon – the first being Friday’s technical resistance breach.

Marcus Ferdinand, an analyst with Thomson Reuters Point Carbon, noted that the front-year futures had broken out of a bearish trend in place since their August peak.

The second trader said prices had now entered a new upward trading channel.

“Prices don’t seem to want to go down,” the first trader added, referring to this week’s double bottom of €8.06 touched on Monday and Wednesday.

“If we end the week above €8.24 then that’s very bullish.”

He also questioned from where EUA sale volumes would come that could push the market lower, noting that many industrials are holding on to their length in anticipation an overall permit deficit during the EU ETS’ Phase 3 (2013-2020).

A poll of 11 analysts conducted by Carbon Pulse this week found that only three expected the front-year EUAs to end this year below current levels.

Market participants also pointed to German clean dark spreads, which on Friday remained within sight of recent one-month highs.

European coal prices rose in the week’s final trading session, but the gains were largely offset by a higher euro and firmer German baseload power prices.

CERs

Meanwhile, CER prices eased on Friday after the futures for near-term delivery hit a two-year high earlier this week, with the front-end of the curve remaining in steep backwardation.

The Dec-15s closed 1 cent lower at €0.60 on Friday afternoon, on volume of 206,000 units changing hands.

The daily futures and Dec-15s have been trading some 9-10 cents above the Dec-16 CERs, a spread that several market participants said represented an attractive arbitrage opportunity for anyone sitting on unhedged inventory.

Some traders have speculated that Dec-15 and spot CER prices have risen in part due to the UN last week warning CDM participants of “unavoidable delays” in the processing of administrative actions and payments due to the agency’s IT systems being overhauled over the next month or so.

“Some people have sold on the Dec-15s, so if you don’t get your credits then you need to unwind your short (position),” the first trader said.

Market participants have also postulated that CER sellers are squeezing the few remaining buyers amid the low supply of EU ETS-compliant credits, adding that some speculators could be taking a punt on the units ahead of December’s UN climate summit.

While the emissions reduction plans submitted by most governments imply little additional demand for Kyoto Protocol credits post-2020, some traders may be betting on that changing as countries further raise their CO2-cutting ambition or as offset appetite emerges elsewhere, for example from the global aviation or shipping sectors.

Below are this past week’s EUA auction results, featuring the clearing price, distance to front-year EUA futures in the secondary market, and bid-to-cover ratio:

05/10/2015 EU 2,918,000 €8.16 -0.03 2.91
06/10/2015 EU 2,198,000 €8.16 -0.01 3.62
07/10/2015 DE 781,500 EUAAs €7.97 -0.22 4.69
08/10/2015 EU 2,198,000 €8.11 -0.02 4.13
09/10/2015 DE 3,198,000 €8.16 +0.01 3.93

And next week’s scheduled sales:

12/10/2015 EU 2,198,000
13/10/2015 EU 2,198,000
14/10/2015 UK 3,123,000
15/10/2015 EU 2,198,000
16/10/2015 DE 3,198,000

 

Implied EUA carry trade annual returns German clean dark spreads
Dec-15 Dec-16 Dec-17 Dec-18 Cal Yr Price Wk chg
Spot 1.335% 0.902% 1.087% 1.188% 2016 €4.47/MWh +0.08
Dec-15 0.838% 1.072% 1.179% 2017 €3.51/MWh +0.02
Dec-16 1.306% 1.360% 2018 €3.16/MWh -0.03
Dec-17 1.407% (based on 36% efficiency factor)
(does not include transaction costs)

 

By Mike Szabo – mike@carbon-pulse.com

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