ANALYSIS: Vattenfall lignite sale could hit EUAs as massive hedging book is left dangling

Published 10:59 on April 21, 2016  /  Last updated at 13:04 on April 21, 2016  /  EMEA, EU ETS

Vattenfall’s sale of its German lignite operations to Czechia-based EPH could put EU carbon prices under pressure if decisions are made to either offload the large carbon portfolio associated with the assets or to hold off buying emissions allowances.

Vattenfall’s sale of its German lignite operations to Czechia-based EPH could put EU carbon prices under pressure if decisions are made to either offload the large carbon portfolio associated with the assets or to hold off buying emissions allowances.

In announcing the deal on Monday, Vattenfall said the forward power hedges held against the assets it’s selling to EPH, positions worth around SEK 9 billion (€980 million), will remain with the company after the potential tax implications prevented their transfer.

A Vattenfall spokesman confirmed to Carbon Pulse that the holdings include carbon units, and that no separate deal to sell those hedges was being considered at the moment.

That means Vattenfall, having drastically reduced the size of its CO2-emitting generation portfolio, could opt to unwind the positions, while EPH may need to massively scale up its EUA buying to cover its newly-acquired exposure.

“Depending on how EPH hedges the lignite assets, that could be bearish for carbon as presumably Vattenfall will now unwind theirs,” said Jonas Rooze, an analyst at Bloomberg New Energy Finance (BNEF).

Analysts at ICIS-Tschach Solutions estimated that Vattenfall’s current EUA holdings could be as high as 150 million tonnes, which would equate to around 8% of last year’s total emissions from installations covered under the EU ETS.

As such, if sold over several weeks or even months it would likely decimate carbon prices, which at €5.55 are still reeling after a 40% drop in the first six weeks of the year.


But Trevor Sikorski, head of gas, coal and carbon analysis at Energy Aspects, isn’t ruling out a separate deal for the hedges between the two firms.

“Vattenfall is long and these facilities are short, so in terms of volumes they should be a good match,” he said.

“However, if there’s any mismatch between the buyer and the seller, or if the plants are operated considerably differently under the new owners compared to the old ones, then it could impact the market.”

Sikorski added that given they are German lignite-fired plants, it’s likely they will continue to be run at a high capacity to provide baseload power, especially as EPH will want to recoup some of their investment.


Vattenfall is the second biggest EU ETS emitter with CO2 output of 96.3 million tonnes last year. Some 79.3 million tonnes of that came from the German units it is selling, with just 2.5 million EUAs obtained as free allocation from the government, according to Carbon Market Data.

To lock in profits, large utilities in Western Europe tend to buy the corresponding fuel and carbon allowances when they sell their future power generation, which they start to do up to three or four years in advance.

But hedging strategies vary considerably across Europe, with regulated companies operating in liberalised markets having access to more derivative instruments and bank financing.

Utilities to the east of the bloc, on the other hand, tend to manage their power sales and subsequent fuel needs on a spot-to-Y+1 basis.

Vattenfall has sold 95% of its planned 2016 electricity output, 79% for 2017 and 57% for 2018, according to its full-year 2015 earnings in February, meaning that it holds enough carbon units to cover all of that generation.

Hedging figures for EPH were not available.


German power prices have fallen by around 40% since 2014, squeezing margins for Vattenfall’s lignite-based units, but EPH is betting they will rebound in the next few years as Germany completes its nuclear phase-out by 2022.

“EPH’s entire investment strategy is based on the expectation of power price recovery, so they may prefer not to lock in what they see as meagre profit at this point,” said BNEF’s Rooze, referring to how the company may seek to approach hedging.

EPH has built up a large generation portfolio across Europe, and in the wake of another unseasonably mild winter and as many of its plants may qualify for free EUAs under Article 10c of the ETS Directive, it could be sitting on a sizeable inventory of unused carbon units, which would mean it wouldn’t need to pick up all of Vattenfall’s spare holdings.

In any case, the deal is expected to close by the end of August, meaning EPH is unlikely to start selling forward power or buying carbon before that time.

That, in turn, removes some of the demand typically seen during the first six months of the year, when many big emitters do the bulk of their carbon buying.

And if EPH opts to further stall in buying EUAs, with a view to securing fatter profits by waiting for a recovery in power prices, then the carbon demand linked to future generation from Vattenfall’s German lignite assets could remain elusive.

Furthermore, Vattenfall could exacerbate the bearish effect this would have on the market if it decided to offload its carbon holdings.


But ICIS-Tschach doesn’t think Vattenfall will sell a significant amount of its spare EUAs because its Swedish government owners are unlikely to want to subject the EU ETS to further volatility or price pressures.

Vincent Ehrmann, an analyst with ICIS-Tschach, said Vattenfall may have worked out a deal separate to the acquisition to utilise its hedges against EPH’s generation, an arrangement that would effectively have a neutral impact on the carbon market.

“It is uncertain if Vattenfall will sell the hedge and EPH will buy it separately. It could be possible that EPH sells a virtual lignite power plant to Vattenfall which equals the size of the hedges. This would result in EPH operating the plant, while Vattenfall delivers EUAs – to cover the compliance obligation of the respective power – to EPH.”

He said that there were still many uncertainties related to the deal, and that any EUA market impact might be months away.

“There are a lot contractual permutations as to how this could turn out,” Sikorski added.

By Ben Garside and Mike Szabo –