Choppy times for carbon

Carbon market participants should brace themselves for more price volatility in the week to come - have we reached the bottom at EUR 55/t, or could prices climb to EUR 100/t?

Listen to a discussion on the key drivers going forward, and whether compliance buying could offset selling by speculative and industrial companies. 

Guests: 

• Ingvild Sorhus, Lead EU Carbon Analyst, Refinitiv
• Bernadett Papp, Analyst, Vertis Environmental Finance

Transcript

Richard Sverrisson, Editor-in-Chief, Montel: 0:05

Hello listeners and welcome to the Montel Weekly podcast, bring You Energy Matters in an informal setting. In today's pod, we look at what is currently driving prices in Europe's carbon markets, as generally in other energy markets. The outlook changed dramatically on the 24th of February. A few weeks ago, some analysts expected prices to hit a hundred Euros a ton, but instead they plunged a 55. Why they're such a big fall and what are the reasons for the current rebound. Above 70 Euros have carbon allowances become delinked from other commodities. Helping me, Richard Sverrisson, to address the reasons for the huge volatility are our friends, Ingvild Sørhus of Refinitiv and Bernadett Papp of Vertis. A warm welcome to you both. I'd like to start off talking about the sell off that happened. What was this all about? Was this, is this speculators suddenly just pouring outta the market?

Ingvild Sorhus, Lead EU Carbon Analyst, Refinitiv: 0:59

I think it was just all, quite a lot of different factors weighing in. And then when a snowball started to roll it was just this snowballing. All these factors all together, it's moved in completely opposite directions from the other energy commodities. And I would say the immediate reaction was most likely kind of that there were kind of people in the market, players in the market that's was liquidating the EUA positions to cover margin calls due to this kind of. Big increase in energy prices and then I think it was this snowball started to roll and I think for instance, one was probably like, I would say unfounded reasons and that E-U-E-T-S could be weakened. It's always this. Policy risk. And I think you saw some rumors, like people putting it out on Twitter, e uts could be suspended, there will be more supply to the market. You had this kind of bus in the market as well kicking in. But I think it also and of course when going this deep down, it would also trigger quite a lot of stop losses for those that are having positions in the market as well. And of course, I think, you have had industry. Receiving free allocations already for 2022. And that also some selling from industry that needed to raise cash to improve cash flows. I think that's could be part of the reason as well. And also, one thing on the policy factors factor as well. We're in the middle of the fit for 55 policy debate. Worries that this would be postponed or in the back seat because there was a completely new crisis in Europe. So I think it was this, all these factors at one one thing contributing to this fall. And of course, investors pulling out of the market when prices were just going so steep down.

Richard Sverrisson, Editor-in-Chief, Montel: 2:45

You'll be pleased to know that mantel News didn't put out any gossip or rumors, but Bernadett, if I can turn to you, do you share that view of why prices fell so dramatically in that period?

Bernadett Papp, Analyst, Vertis Environmental Finance: 2:56

Yes I mainly share invi view on the market and why the price was plummeting 2 55 Euros last week. Actually, market participants independently, if they are compliance entities in the UETS or simple, let's call them speculators or financial entities without any compliance obligation they had to digest a shock. They were in a panic mood. And of course for the speculators, it was, let's say, easier to liquidate their positions because they do not need the LNCs for compliance purposes. But we experienced in our case, as you might know, or company vir, environmental finances, serving compliance entities or clients also took a step back, to be honest, also mentioned, member states were distributing 2022 free allowances. And although before the invasion of Ukraine by Russia, many of our clients decided to purchase their shortage rather than use 2022 free location to cover their 2021 verified emissions. Now with this uncertainty many of them took a step back and decided to rather borrow 2022 free allowances in order to cover their previous emissions. Simply because they are still kept in uncertainty. They do not know what the future brings. For them. They have seen gas prices skyrocketing, electricity prices increasing, and let's confess. For their businesses, for their industrial processes they need these commodities. And therefore whatever liquidity, whatever cash they had, they decided to keep for gas and electricity. So what we have seen from their side was rather hoing purchases and and borrowing allowances. However, I also have to say that. There were a couple of companies among them who tried to catch the dip and used the falling prices to top up their hoardings buying allowances for this compliance or the next. So the picture is really different from, let's say, company to company and also country to country. Regarding speculators of course transactions on the exchange happen anonymously. There are always market rumors but we could see, and of course there are also official reports we have access to. Is that indeed. Many financial entities reduced their holdings in the carbon market. They turned to safe heavens as it's a rational thing to do in the time of a war. They are living right in right now. Many of them have also lost funds from Russia. They were using money from Russian entities. They lost these days. And of course, as Ingrid also mentioned we have to keep also in mind the technical aspects. So the price fell below significant support levels that triggered top loss orders in the market. So again, a mixed picture. Indeed.

Richard Sverrisson, Editor-in-Chief, Montel: 6:10

Absolutely. That's very clear. So if I can turn to you Ingvild and ask, now we've seen the rebound. What are the reason, reasons for that? We're up above 70.

Ingvild Sorhus, Lead EU Carbon Analyst, Refinitiv: 6:18

I think first of all, it's the plunge wasn't really fundamentally driven at any point. So in that sense, it seems, we're still looking at a year where you will have quite a lot of coal burns because of this tight gas situation and the gas crisis that Europe is in. And also, so we are, we're heading towards another year where we see high power sector emissions. I think it's still there will be most likely that we'll see. We see news now that industrial companies are reducing production due to the high energy cost, high electricity cost high, yes. Gas prices. So of course this demand disruption could be on the barrier side, but still we have this safety net that helped European carbon market through. The previous crisis, which was the Corona Pandemic, when a demand was plunging, and then this safety net, this certainty that okay, if you would have lower demand, that would be soaked up by the smart stability reserve even though with the delay. So we saw that supporting prices back in 2020, and I think that is also giving certainty to the market that we're not getting this. Copy, paste of the economic recession that we had early in, in kind of 2008, 2009. In the longer term you have the 2030 target is still 55% below 20 1990 levels. You have a climate neutrality target in 2050. So of course, you know that policy is on the supportive side. And I would also say I mean we're heading towards compliance reporting for 2021. Emissions is like the deadline is end of March, and compliance. To comply with your 2021 emissions as end of April. So I think the still this compliance for 2021 emissions is still also a supportive element of why we have seen kind of the rebound from 55 and up to above 70.

Richard Sverrisson, Editor-in-Chief, Montel: 8:15

We'll get back to some of those issues a bit later on, but do you think then we've hit the bottom?

Ingvild Sorhus, Lead EU Carbon Analyst, Refinitiv: 8:19

Yes. I think we have seen the bottom. That might be a stupid thing to say. Since things are changing quite fast,

Richard Sverrisson, Editor-in-Chief, Montel: 8:26

it's a very brave thing to say.

Ingvild Sorhus, Lead EU Carbon Analyst, Refinitiv: 8:30

I think one, one thing for that is that these fundamental factors are all a bit supportive. But also that, I mean like this psychological floor is, I would say is also the 60 level.'cause the 60-year-old Perton is really what the coalition, the German coalition government meant, came out and said in their coalition document that they was they intended to work to get ice floor in the EUTS on the EU level. If that was impossible, they would imply or get a 60 euro. Price floor for those sectors covered in e UTS at 60 euros. So I think this kind of mental barrier of 60 is still could hold up prices.

Richard Sverrisson, Editor-in-Chief, Montel: 9:13

What do you think, Bernadett? What could drive prices to 55 or even below that level? Again.

Bernadett Papp, Analyst, Vertis Environmental Finance: 9:19

I'm not this brave as Ingvild to be honest. So I would only dare saying that 55 was the bottom. If I could see the end of the war, which unfortunately I still cannot, and I think that the longer the war lasts. The more severe the economic consequences and there can be another wave of panic. As I've mentioned before, it's very difficult to say that it's over because simply the war is not over. However, I also think that on the long run we'll have higher prices because as Ingrid also mentioned, we have a 2030 target and a 2050 target. We have to reach. And it was very interesting that the new IPCC report has been just published couple of days after the start of the war, and it raised our attention on the fact that we have to act on climate change. Otherwise the consequences will be devastating. And in the eu the emissions trading system is one of the main tools to fight against climate change and to reduce greenhouse gas emissions in the economy. So therefore, I think that even if we see lower prices in the upcoming weeks because of the negative consequences, mainly economic consequences of the poor on the long run, we see higher carbon prices. Because this is absolutely not necessary in order to decarbonize or industrial processes, the power sector and the economy as a whole,

Richard Sverrisson, Editor-in-Chief, Montel: 11:02

what's your view on 2021 emissions? Bernadett, obviously Ingvild mentioned the compliant spying that will be going on in March and April. It's obviously gonna show a sharp increase over 20, 20 levels. So that's the outlier. That's when. The demand destruction, the year of demand destruction and the COVID pandemic. But what's your view on 2021?

Bernadett Papp, Analyst, Vertis Environmental Finance: 11:23

We made our calculations and we are also speaking to lots of compliance entities because we are serving them. But we experienced was a definitely better year in 2021 regarding activities than in 2020. So all in all in, in many sectors. We expect numbers increasing regarding verified emissions in the power sector as well, especially because many companies had to use more fossil in some cases. For example, in, in Romania, we received reports from clients that they would like to burn gas, but physically it was not available, so they had to turn to even more polluting fuels. So therefore, in the power sector, we also expect higher emissions than we have seen in 2020. And maybe another sector that is, is worth highlighting is aviation sector. Where we also expect to see significantly higher emissions than we have seen in 2020. Of course, still below the 2019 levels, but tends the picture a little bit. Is actually the effect of gas and power prices in the last quarter of 2021. If you remember, there have been plenty of company announcements made. Maybe I might highlight fertilizer sector that suffered quite a lot from high gas prices and they had to reduce or even hard productions. So this might dent the picture a little bit, but looking at the overall number. We expect year on year increase in verified emissions compared to 2020.

Richard Sverrisson, Editor-in-Chief, Montel: 13:07

Could I ask you to put a figure on that, or even a percentage rise? I know it's, I know it's early days yet.

Bernadett Papp, Analyst, Vertis Environmental Finance: 13:12

Yeah, so all in all compared to 2020 what we calculated is around between four and 6%.

Richard Sverrisson, Editor-in-Chief, Montel: 13:20

Thank you. And Ingvild, what's your forecast for last year's emissions?

Ingvild Sorhus, Lead EU Carbon Analyst, Refinitiv: 13:23

Yeah, so it's much of the same story As Bernadett says, we will see an increase in emissions. I don't have the number in front of me, so we coming out with a our final estimates very shortly.

Richard Sverrisson, Editor-in-Chief, Montel: 13:35

Okay. Excellent. Hopefully you can pass them on to us and we can put a story out on that. But I think you mentioned as well as we cut, or the intention is to cut our use of Russian gas. What does this mean for carbon? Does this mean, in Estonia, they're a extending shale oil production. There we're burning more coal in places like Germany. What does that mean for carbon? Is it surely that's quite a bullish factor?

Ingvild Sorhus, Lead EU Carbon Analyst, Refinitiv: 13:58

We are seeing kind of higher power sector emissions happening. But of course that's more for the shorter run. You see also the communication from the European Commission that they have a strong fo focus on rapid clean energy transition and kind of the push. That you need to speed up the renewable phase compared to even what was proposed earlier to lose this dependence on Russian gas or fossil fuels, which you rely on imports. So I think yes. In the short term. That's British thing for carbon, but of course in the longer term, that means that you could actually speed up the power sector emission reductions and also focus on energy efficiency measures. So I think this communication is also. Giving a stronger kind of push for speeding up energy efficiency across Europe as well. So it's really so in the longer term, I think Timberman also said earlier that, if the Green deal happened earlier, that was before the Ukrainian war. But when we had the energy crisis of kind of gas hitting record high levels, he also said that, okay, we need to push for a degree deal. We need to the reliance on fossil fuels, we should lose that dependence. So overall, I would say that picture means that you will are you putting more measures in place to get sooner emission reduction cuts regardless of the carbon price? Then that could also be be a bearish factor for carbon. But that said, I was also of course the MSR market stability reserve is also working when emissions are increasing or decreasing. Of course, if you would see last year you saw an increase in emission. That means oversupply is shrinking, so that means marketability is taking out less. That could also be the case if then emissions are rising due to a higher coal burn and higher kind of oil oil power production as well. And then looking forward, if that means a more kind of rapid in inflow of renewables and lower power sector emissions. The marketability also will work on surplus regardless of if it's increasing or decreasing.

Richard Sverrisson, Editor-in-Chief, Montel: 16:12

I think you, you both mentioned these very high prices for gas, for electricity we're on very volatile times. Bernadett, what kind of advice would you give to. To people trying to hedge their carbon exposure in the, in these kind of markets.

Bernadett Papp, Analyst, Vertis Environmental Finance: 16:28

It's very difficult to provide any advice in these difficult times because as I've mentioned before, if companies need their liquidity to continue their business, then you won't be able to convince them to purchase allowances. Because they would think that, okay, I would need maximum dose allowances in one year's time when the next compliance comes. However, we always used to suggest to our clients that in the times of volatile prices, and let's be honest, carbon has been always volatile. Maybe not to this extent. But always the wise thing is to achieve, let's say, a nice average price for the year. This means that the best thing companies can do is cutting their. Hedging needs into trenches. Depending on the volume, of course purchasing LNCs every quarter or every month or a, or on a more regular basis. And this way achieve a nice average price for the year because it's impossible to fish the bottom. No one has been successful doing that in the past. Another thing would be that could be a good idea in these times when cash is really very essential for the companies just to secure their future price of covering their emissions via purchasing options, for example. Cool options this way they fix the price, of course, at a certain premium they have to pay in front. But then they'll know the cost they face for the compliance. So there are a couple of strategies companies might follow, but of course if priorities are different for the companies, then it's very difficult to give an advice. And no one of us lived in times of war until now, and therefore it's very difficult and challenging.

Richard Sverrisson, Editor-in-Chief, Montel: 18:29

No, absolutely. I sure there's no, no sign of the end to this volatility. But if I can just ask you a final question. So starting with you Ingvild, do you expect us to hit a hundred euros a ton this year?

Ingvild Sorhus, Lead EU Carbon Analyst, Refinitiv: 18:43

I think that's very difficult to say now. In this super volatile times, and we have plenty of bullish and bearish factor kind of that. Could possibly kick in. So I think there's big uncertainty. It, I think it's like not easy to say if it's going to hit a hundred or not. We, before this Ukrainian war, I mean we had more kind of bullish we saw Q1 as bullish, especially being supported by compliance. Since 2021 emission arose. So I think it's I think I will not bet on a hundred if we're reaching it or not.

Richard Sverrisson, Editor-in-Chief, Montel: 19:18

Okay. Fair enough. And how about you, Bernadett?

Bernadett Papp, Analyst, Vertis Environmental Finance: 19:21

I'm also cautious here, so I would say that of course we cannot exclude the possibility, however, the probability has decreased significantly compared to the times before the war.

Richard Sverrisson, Editor-in-Chief, Montel: 19:34

And on that note, I'd like to thank you both very much for joining them on our weekly podcast this week. So listeners, you can now follow the podcast on our own Twitter account apply named the Montel Weekly podcast. Please direct message. Any suggestions, questions, or let us know if you think you have a good idea for a guest on the show, you can also send us an email to podcast@montelnews.com. Lastly, remember to keep up to date with all that's happening in energy markets on Montel News. You can subscribe on Apple Podcasts and Spotify or wherever you get your podcasts from. Thank you and goodbye.