Carbon Pulse Dialogues are discussions about carbon markets and climate policy by a selection of leading experts.
Greece’s long-running debt crisis may finally be nearing its climax.
The debt-riddled country has temporarily closed its banks this week to prevent a run on them, and it will hold a July 5 referendum that effectively leaves the next decision regarding the country’s future in the eurozone in the hands of its electorate.
Should the majority want to stay in the currency union, the next key date for the economically-ravaged Mediterranean state becomes July 20, the day two Greek bonds totalling €3.5 billion are to be repaid to the European Central Bank. Failure to do this in the absence of a new agreement with its creditors would all but ensure a so-called ‘Grexit’.
European carbon prices briefly dropped to a one-month low of €7.25 early on Monday on the back of the announcements regarding Greek bank closures and the national referendum made this weekend.
Carbon Pulse asked a handful of European emissions analysts what Greece’s exit from the eurozone would mean for EU carbon prices and the wider Emissions Trading Scheme.
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Risk of financial contagion is likely to drive EUA prices this week, with Greece shutting its banks and imposing capital controls ahead of a surprise referendum this weekend on its future in the eurozone. The worsening outlook for Greece could trigger increased allowance sales from Greek companies, but this is unlikely to make a big dent in the market balance for EUAs in the medium term.
The situation in Greece has already led to a strong correlation between the euro and EUAs during the past weeks. We think this will continue in the run-up to the (July 6) plenary vote on the MSR. This may mean there is no bull run for EUAs of the sort often observed in the lead-up to such votes.
A Greek referendum result in favour of the deal proposed by the country’s creditors could be bullish for EUAs, particularly if this is followed by an affirmative plenary vote on the MSR. Should the Greeks vote to reject the deal, this will likely offset any MSR optimism because Greece would be seen as setting a precedent for other countries to leave the euro area.
Traders we spoke with raised concerns over possible selling of EUAs by Greek installations, as future enforcement of the EU ETS by the Greek government would be far from certain. Mohamed El-Erian, chief economic advisor at Allianz, estimates an 85% probability that Greece will be forced to leave the Eurozone one way or another over the next few weeks, according to a Bloomberg News article. However, should Greece leave the euro it will likely remain part of the European Union, according to lawyers we spoke with, suggesting it would also remain part of the EU ETS.
In the likely case that Greece remains part of at least the EU and its ETS, there ought to be no medium-term impact on EUAs from allowance sales by Greek companies. We estimate that Greek companies ran a fundamental surplus of just 20 million tonnes over 2008-14, excluding surplus from installations not managed by holding companies whose majority of emissions are not in Greece. Allocation to these firms is around 12 million tonnes for 2015, implying they could sell at most 32 million tonnes this year, roughly equivalent to total EUA auction volumes from today until 18 July.
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Any ‘Grexit’ model would likely have a bearish effect for EUAs. Given the small size of Greece in the context of overall EU emissions, any effect would be indirect through the wider economic impacts rather than EU ETS specific issues. In case of a default, we expect to see Greece leaving the eurozone but not the EU as we would expect a strong political will to keep the Union intact … A Greek exit from the eurozone would not have any consequence for the country’s participation in the EU ETS … The Market Stability Reserve (MSR) will not start operating until 2019, probably too late to cater for the effects of a potential Grexit in 2015.
Our model suggests (a Grexit) will cut EU ETS emissions by 34 million tonnes in 2015 and 12 million tonnes in 2016 compared to our base case. In such a scenario, we do not expect a radical change to our long-term EUA price forecast, as GDP assumptions for the EU would likely not be significantly affected by a Grexit. We see a slight downward potential for EUAs in the range of 0.2-0.3 €/t over the next two years … However, this scenario does not account for the risk of contagion. Should other debt-stridden countries follow the Grexit, we will likely see more severe macroeconomic turbulences in Europe. This would also entail a significant downside risk for EUAs. However, the risk of the crisis escalating to other eurozone countries seems smaller today than what would have been the case only a few years ago. Overall, we therefore see the potential impact on EUA prices of a Grexit to be small, and only felt in the short term.
In terms of the wider EU ETS, it’s not that big a deal. A Grexit is a monetary union issue, not EU membership issue, so our assumption is that Greece coming out of the eurozone wouldn’t mean leaving the EU. EUAs would become more expensive for Greece as it would have to buy euro-denominated allowances like the UK. So in that sense it’s not that big a deal. Although it would be generally bearish for the market because it would lead to macroeconomic disruption both inside Greece and outside, and that will be somewhat painful. It could also lead to further deterioration of the euro in near term, and that has mixed impacts on EU economies. For EU industry, it would make them more competitive by bringing down the cost of their products. For EU utilities, it will hurt them by raising the price of (dollar-denominated) fossil fuels while potentially cutting European energy demand. A deep recession in Greece will impact its demand for imports from its neighbours, and weaken the outlook of European economies.
That said, the impact of another slowdown in Greece on the EU ETS is unlikely to be as severe as in 2011, as there’s not as much speculative length stored up in the market as there was back then when we saw EUA prices fall from €16 to €12 over a week.
It will certainly be a source of volatility. We saw some pretty big price jumps earlier today, although as they didn’t continue downwards it looked like it was just a bit of speculative trading rather than something more fundamental or indicative of significant length being washed out of the market.
The real pinch point won’t be this week. While Greece is getting closer to the point of no return, it will more likely be July 20 than this week. And until then, it will probably be a bit more choppy than we’ve seen recently. The reality is there’s less speculative length in the EU ETS than we used to see.
A Grexit isn’t going to have much of a direct impact on the EU ETS, as it’ll be more on the euro and the wider eurozone economy. And I’m confident that the euro won’t crash, and if it does it will quickly rebound. So I would be pretty surprised if this it caused huge movements in EUAs. The market has consolidated, trading in narrow range over the past 2-3 months, and trading positions have crystallised, with traders expecting more movements to come due to supply-side influences than demand-side.
This also shouldn’t affect the upcoming ETS Directive review, other than potentially slowing down the process a bit because Grexit will become a distraction for EU lawmakers. The whole thing is more about politics than economics.
It seems to me that this market is just reacting to a possible Grexit rather than doing the homework required as to what it would mean in terms of actual impact to the EU ETS. Prices are more likely moving for sympathetic reasons rather than for assessment-justified ones.
Traders may have changed their positions (in EUAs) due to other asset classes, but besides that I don’t see any reason why prices should be so bearish today. Over the past several months we have been advising clients about a price-supportive environment for EUAs. Buying EUAs when prices dip is one way to act on this. That said, we also advise that prices are not going to go into double digit any time soon.
The EUA price has done nothing so far this year. It’s had a couple bearish moments, but if you look at the broader spectrum, the price remains in an upward-sloping channel that started mid last year. The following refers to the outcome of one of our models that says that over the last four weeks the trend has changed, and is now mildly negative (-0.15%).
We bounced right off the 20-week moving average around €7.25 this morning, and it’s the third time we’ve done this since the week ending May 29. The market will still be prone to some volatility, but much less so than six months or a year ago. Until the €7.65 technical resistance level is broken, we’ll continue to oscillate in this channel.
Even if Greek industrials were tempted to sell EUAs ‘just in case’, unless they have overseas bank accounts it is unlikely to solve anything for them as there are restrictions in place that prevent them having access to the money. If the worst were to happen and there is a Grexit, the money may well disappear completely as the Greek banks will only be able to replace the Euros with Drachma, the value of which will be highly uncertain.
By Mike Szabo – firstname.lastname@example.org