Analysts at Energy Aspects have slashed their EU Allowance price forecasts for the next five years by at least 30%, as the bullish sentiment that led the market higher in 2015 has dissipated and the bearish reality of ample supply and scarce demand that has for years plagued the EU ETS returned.
“For 2016, we forecast that prices will average €6.60, as higher auction levels and the start of fuel switching begin to accelerate through the year,” the analysts wrote in their monthly report released on Friday.
While that represents a 9% gain on current front-year EUA prices, it’s a 33% drop from Energy Aspects’ previous estimates published last October.
The Dec-16 contract ended 2015 at €8.29 but has since plummeted by as much as 32% to a 20-month low of €5.61 last Tuesday, before ending the week at €6.07.
“We do think that given the lower starting point, some minor upward drift in prices is possible … However, current market dynamics suggest that prices will only see support at lower levels and face headwinds to gain, as the market looks set to bet against any price increases,” Energy Aspects’ head of carbon, gas and coal analysis Trevor Sikorski wrote.
The analysts see prices sliding to around €6 in 2017 and €5.25 in 2018, marking respective 40% and 42% decreases from their prior projections.
They pointed to a number of bearish factors that would weigh on the market over the next few years, including increased EUA auction quotas from the wrapping up of the bloc’s Backloading programme, which will have removed 900 million allowances in supply by the end of this year.
Government sales increase by around 100 million units in total this year to approximately 730 million, before rising by a further 200 million or so next year to resume pre-intervention levels.
In addition, Energy Aspects highlighted the coal-to-gas switch, noting that profit margins for European gas-fired plants are closer to those for coal plants than they have been at any time since 2012, meaning more of the cleaner-burning fuel may work its way into utilities’ energy mix this year.
As a result, the analysts predicted that emissions from the EU power and heat sector, which make up some two-thirds of those capped under the ETS, will fall by 32 million tonnes or 2.5% in 2016.
This, they said, will contribute to total ETS emissions declining by 28 million tonnes to 1.793 billion in 2016, and to the oversupply currently hanging over the market being cut by almost 200 million tonnes to 1.58 billion. This comes after the glut was slashed by some 325 million last year from 2014’s 2.1 billion, they added.
“Given that the level of inventory is still high, and given the addition of auction volumes this year [that] have not yet even started to be sold in the market [because January’s sale levels are down year-on-year], any recovery in prices is solely in the hands of the utilities,” the analysts wrote.
“[But] with a mild winter so far, MiFID 2, and poor power spreads all conspiring against copious buying, any significant upward pressure on prices looks optimistic.”
The analysts said utilities that have generated less power than anticipated so far this winter could unwind some of their hedges and sell carbon back to the market, while regulatory concerns surrounding Europe’s MiFID2 rules “could also be playing into the reticence to hedge further out”.
Energy Aspects also cited sizeable drops in open interest figures for EUA futures for delivery from 2017 onward. While this could be the result of a drop in speculative interest, it could also be due to lower levels of utility hedging, either from more forward sales of gas-fired generation than coal or just fewer power sales.
Looking further out, the analysts forecast that EUAs would begin to climb again from 2019, rising to average €6.80 that year before jumping to €9.60 in 2020. Those estimates, however, have been sliced by more than 30% since October.
For Phase 4 (2021-2030), the analysts see a mean price of €30, which is down only around 10% from their previous view of €33.
NO REASON TO BE BULLISH
They also examined the recent collapse in prices, noting that it appeared to start with some proprietary and/or compliance positions being unwound and was suggestive of market participants having considerable length to sell
“This felt more like a change in sentiment, as the market was firmly bullish in 2015 … That can be put down to greater macro[economic] concerns, worry over who will buy 100 million tonnes of additional primary volumes, and the emergence of a convincing narrative that the gas market will begin to incentivise more coal-to-gas switching in the power sector, regardless of carbon prices.”
They also cited, as potential contributing factors to the price fall, EUA sales by industrial firms facing plant closures and the shuttering of Swiss trading house Mercuria’s London-based emissions trading desk, which is understood to have had a sizeable prop book.
The analysts suggested that the price fall was accelerated by widespread short-selling by speculators, meaning that a recovery may be more elusive.
“Such positions can lead to a bounce, as some profit taking could be seen. However, if the underlying call remains a sell, such recovery bounces will tend to be short lived as short positions are reopened (as further declines are expected),” Energy Aspects wrote.
“On the downside, there is no fundamental price floor for where EUAs might stop, and with little convincing reason for going long, a significant price recovery is unlikely to be on the cards – despite 2016 being likely to see a further net draw on inventory. While it may be too early to call the bottom, prices will eventually stabilise. We currently expect €6 to be where this stability happens, but we see plenty of downside risks.”
“With the fundamental outlook for 2017 and 2018 even worse than for 2016 … there simply is no good reason for market sentiment to go back to being bullish.”
By Mike Szabo – mike@carbon-pulse.com
