A May dip in EU carbon prices is a short-term blip and prices will rise later in the year due to supply curbs, analysts said.

“We think as time progresses, the cumulative withdrawal of volumes from the market driven by backloading should pave the way for more sustained price increases in H2 2015 and in 2016,” Energy Aspects wrote in a monthly research note emailed on Friday.

The analysts kept their EUA price forecasts unchanged, predicting the front-year futures will average €7.80 in 2015, increase to €10.50 in 2016 and to €21.00 by 2020.

This is despite a “somewhat unexpected” easing in prices in the second half of this month following an agreement by lawmakers to start the MSR in 2019, two years earlier than initially proposed.

The benchmark Dec-15 contract settled at €7.35 on Friday, 1% or 8 cents down month-on-month, with EUA prices falling back from a mid-month peak of €7.75.

BEARISH MONTH

“It feels like some profit taking from any speculative longs put on as we went through the MSR process. As prices started to come off, it encourages more selling as mark-to-market losses start to show,” the analysts said.

They added that prices had also come down this month due to less compliance buying from utilities, the market’s main source of demand.

The report identified that utilities’ Q1 hedging levels were down year-on-year and EUA volume was down 30% over the first five months of the year, with open interest lower particularly for futures contracts two or more years ahead.

The analysts said this was likely due to persistently low dark spreads damping the incentive for power companies to sell their electricity forwards, uncertainty over the trading restraints from upcoming Mifid II financial regulations, and doubts over the effects of Germany’s plan to limit emissions from ageing coal generators.

“With the normalised call on thermal generation falling, the carbon volume the utilities need to hedge should also be reducing. And all of this helps explain the observed patterns of lower year-on-year hedging ability,” they added.

BULLISH FUTURE

Energy Aspects said they still expected allowance prices to rise by the end of the year, with backloading tightening supply by withdrawing 300 million and 200 million EUAs from auction schedules over the next two years.

“We still feel the market is tightening, and given the healthy 255 million tonne level of offset use in 2014, the market has fewer offsets held to hedge the future positions,” they said, referring to EU data out earlier this month that suggested the remaining Kyoto Protocol offset usage limit amounted to only around 20 million units a year to 2020.

“Why is the market not seeing a more sustained upwards price rally? The short answer is the MSR is still a long time away, and the market is just not in a position to support much in the way of long term buying and holding of EUAs,” they added.

By Ben Garside – ben@carbon-pulse.com