Cheaper European gas relative to coal will exert bearish pressure on EU carbon prices in 2016 and 2017, London-based Energy Aspects said on Wednesday, trimming their EUA price estimates for those two years by between 7% and 14%.
The analysts now predict front-year EUA futures will average €9.80 next year, which is down from a previous view of €10.50 but some 22% above current levels. They also cut their 2017 mean price view by €2 to €12.
Energy Aspects left their forecasts for 2019 and 2020 prices unchanged at €18 and €21 respectively, adding that Phase 4 (2021-2030) prices were seen at around €41.
They also retained their estimate for the Dec-15 contract to climb from current levels and average €8.50 in Q4 2015, but said sizeable auction volumes of 152.7 million EUAs to come in the final three months of the year could provide some headwinds to any attempted prices rises.
“While there are a number of potential obstacles to transitioning to higher (EUA) prices, the one we see as most important is a change in the relative price of gas and coal,” Energy Aspects’ Trevor Sikorski wrote in a report published Wednesday.
He notes that while gas prices have fallen 9% in the past year, making the relatively cleaner fuel cheaper for power generators, this has been outstripped by a 13% drop in European coal prices.
“We are increasingly bearish 2016 and 2017 gas prices, but we think coal prices will find it hard to fall any further, particularly if oil prices rise by $10-15/bbl over the coming period. Even if coal prices stay flat, we expect another 13% reduction in average gas prices in 2016, and further reductions in 2017,” Sikorski said.
“As such, implied fuel switching prices could drop from the levels given by prevailing fuel prices … Fuel switching is likely to play little role in the markets this year, except for in the UK (even there it will be modest), while more renewable capacity additions will keep any increases in check.”
They said implied fuel switching costs were currently in a rough range of between €28 and €70 per tonne of CO2 – figures exponentially higher than current EUA prices.
Cheaper gas compared to coal means utilities may opt to divert generation capacity to gas-fired plants, which emit less and therefore require fewer carbon units. However, more renewables reduces demand for either fuel as well as for EUAs.
2015 EMISSIONS
Power sector demand for EUAs also remains less than expected, Sikorski said, with data from the first seven months of 2015 putting European thermal generation up by around 9 TWh, with gas seeing the biggest increase.
As a result, Energy Aspects slashed their estimates for emissions from the sector that are covered by the EU ETS to growth of 8 million tonnes or 0.6% in 2015, down from a previous estimate of 18 million tonnes or 1.4%.
The analysts also reduced their growth forecast for overall EU ETS emissions in 2015 to 11 million tonnes or 0.6%, down from 21 million tonnes or 1.2%. They predicted that stationary installations regulated under the scheme would emit a total 1.83 billion tonnes.
“Industrial output in most sectors remains weak, with only refining seeing good growth and most other sectors seeing activity at similar levels to last year,” Sikorski said.
“We still forecast some modest y/y growth for industrial emissions of 3 million tonnes (1%) as these are trends that have been observed all year.”
HEDGING
Energy Aspects noted that there was evidence that forward power hedging by utilities picked up along the EUA futures curve in September, with the gap in open interest on the contracts observed between last year and this year narrowing.
Front-year open interest, however, was 20% higher compared to last year, which the analysts said could point to a higher compliance requirement for 2015 emissions, or that some companies were hedging future needs using the front-end of the curve, which is more liquid.
They reiterated a previous view that in the absence of power demand growth, the continued rise of renewable energy capacity would erode utility hedging demand by 10-15 million tonnes annually.
That said, the analysts added that they expect more 2018 volumes to be hedged in Q4 15, “and this is what should keep the market supported as we progress through the year.”
By Mike Szabo – mike@carbon-pulse.com
