To cancel or not to cancel EUAs

Contrary to expectations, potential German coal plant closures over the coming decade may not result in the cancellation of permits relative to their emissions. 

Host:

• Richard Sverrisson, Editor-in-Chief Europe, Montel. 

Guests:

• Bernadett Papp, Senior Market Analyst, Vertis,
• Marcus Ferdinand, Head of EU Power and Carbon Analytics,
• Nora Kamprath Buli, Editor Germany, Montel. 

Transcript

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

Hello, listeners and welcome to the Montel Weekly podcast, bring you the most current energy matters in an informal setting. I'm Richard Sverrisson and I'm joined today by Marcus Ferdinand, head of Power and Carbon Analytics at ICIS. Welcome Marcus.

Marcus Ferdinand, Head of EU Power and Carbon Analytics: 0:19

Hi, Richard.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 0:20

And Bernadette Papp, um, senior, uh, market analyst at Vertis. Welcome Bernadett.

Bernadett Papp, Senior Market Analyst, Vertis: 0:26

Thank you very much for the opportunity joining.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 0:28

Mm-hmm. Welcome. And also by my colleague Nora K, who's editor Germany at Montel. Welcome to you two, Nora.

Nora Kamprath Buli, Editor Germany, Montel: 0:36

Hello.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 0:36

So today we're gonna talk about the carbon market and the German coal exit, but I thought before we go into that. There's a lot happening on the island where I was brought up Brexit. It's having quite an influence on carbon market, Bo debt. Could you, could you explain why and, and what the outlook here is in the different scenarios?

Bernadett Papp, Senior Market Analyst, Vertis: 0:59

Yes, of course. Indeed. We market participants actively following the carbon market, have to keep an eye on any kind of news coming from, from Britain and the uk. Simply because the share of British installations within the European emissions Trading system is significant. And their expected acts are really difficult to to forecast simply because of the uncertainty of the outcomes of the negotiations. First of all, between the UK and the EU and the uk domestically, of course, as we have. Seen that, and actually we have seen in the last couple of weeks, even months, that depending on the kind of news we receive from the uk, the carbon market can react very heavily in both sides, either upwards if the market participants receive some kind of signals. For hope for an organized and exit with an agreement and vice versa falling sharply in the case of increasing chances of a hard Brexit.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 2:08

Okay. Is this something you would agree with Marcus?

Marcus Ferdinand, Head of EU Power and Carbon Analytics: 2:12

Yeah. I mean, first of all, I think I can't I can't hear the word Brexit anymore because it's all over the place and every day you wake up, something has changed and, didn't bring any further clarity. So, um, I mean, now we're looking in a scenario where the UK might or might not exit on 31st of October. Obviously I would say with the latest developments the likelihood for an unordered Brexit, unorderly Brexit hasn't necessarily decreased. Because we still look at the, at the potential for, for them to drop out. In my view, carbon is really trading on sentiment rather than on fundamentals in this regard, um, at the moment. So, and I would also expect in case of a hard Brexit, the major price component will be sentiment. I mean, on the fundamental side, yes, I. There will be allowances coming back to the market. I mean, there are, yeah, there are a few, uh, a few dozen allowances kind of sitting on, on utility hedges and as well on industry accounts. They need to come back to the market at some point. But that will not happen overnight. So market participants were. Able to prepare for that since month? I think the interesting question really is will we see any free allocation or auctions coming to market at some point? For that, I would expect that we would need to have more clarity that Brexit will not happen before mid of March next year. So now deadline extension in case there is no deal because other, otherwise it will be. It will be too tight. The timeline will be too tight in a way to to order to organize compliance and to hand out the allowances to, to UK market participants. So these are, I would say, the, the factors to watch. Will there be any commitment by the UK government to do compliance for 2019? Yes or no? There's a fundamental impact, obviously, and the other is. Well watch the chaos, uh, unfolding and, uh, yeah, take your own view on it. I would say,' Richard Sverrisson, Editor-in-Chief Europe, Montel: you said that there could be potential for a hundred million allowances being more than, more than, so being dumped on the market. What, what would that do to, to, to the prices?

Bernadett Papp, Senior Market Analyst, Vertis: 4:11

I think it would be a shock. For the market participants, because those allowances should have been distributed equally during the year of 2019. And of course, installations have the right to get those allowances before the compliance deadline, which means next April. So. Worst case, those allowances hit the market. If we do not have a Brexit by the end of October in two months, which means November, December to distribute all the 19 allowances in 19, or I would say best case, the allowances come to the market in a little bit longer time until the end of next April, which would be then rather a less. Impact for the market participants, but still a negative impact because the time is significantly shorter for those allowances to hit the market.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 5:03

And the additional maybe issue clouding the market, is the fear of recession or an economic slowdown, could that have a similar impact, do you think? Bernadette.

Bernadett Papp, Senior Market Analyst, Vertis: 5:12

We see that already in the real economy, and we have the feedback from from our clients already from industrial sectors, mainly supplying the car manufacturers that they see their production levels dropping and their emission levels are decreasing in tandem. So this is, this is a fact of course, and they prepare for that. However, we have to mention the two counterbalancing measures. One coming from upside, let's say, from the central banks that realize the problems that they are following very closely, the macroeconomic figures and try to act, first of all, Vita reducing interest rates offering, let's say cheap money to the economy to. Post economic growth. And the second what We should not forget that the carbon market and the design of it, how it works, has changed completely compared to the last economic crisis we experienced. We have a market stability reserve, and if you remember the communication of the European Commission, it was exactly designed to tackle unexpected economic events. This is what the European Commission communicated. I think that the market stability reserve should be able to absorb at least part of the surplus solus industrial companies do not need in the case of a new economic crisis. Okay.

Marcus Ferdinand, Head of EU Power and Carbon Analytics: 6:40

Do you share those? Share that view? What I think we see at the moment is that despite all these parish clouds, in a way hanging over the market, I mean, carbon is trading up extremely well, and it's kind of shrugging off quite a bit of. Let's say that negative momentum building. So I would, I would agree with Bernadette that yes, once the real economy sees it, once we see production levels falling, once we see basically a reduction in emissions, we will also see lower demand for allowances. But. The impact of it on the carbon market, I would say is much more buffered now by the MSR and by the trust in the system that the system actually is able to buffer for these negative macroeconomic effects. So I would say that the price impact that I would expect from an, let's say ongoing. Ongoing, macroeconomic kind, various picture is, is much less severe than what we have seen a few years ago. However, obviously if we go into recession we see quite a long term effect again on industries. So it's not that we only talk about the next half year or so. Right, and I think that's something that we need to watch a bit more carefully. It really depends on how industry sectors will be able to survive that. Also in in a world where trade war is is becoming quite a quite an important kind of, uh, factor to watch. Um, so how do you actually position yourself in, in such a world? Um, and with that, I guess these strategies also by industrial, by industrial participants has changed completely compared to the last crisis. So there is a, I would say a more. Holistic picture that needs to be taken into account. Just looking into the impact on carbon markets, right? Carbon, yes. Is an important component, but in the end plays a marginal role, I would say, when it comes to like a more, um, globally oriented, uh, kind of trade, kind of war discussion.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 8:33

Absolutely. And there is a move to increased protectionism and nationalistic tendencies there Bette.

Bernadett Papp, Senior Market Analyst, Vertis: 8:38

Yes. One additional perspective, if I may. Sure. From the industrial utilities side. As we experience after our talks with our clients, they are also worried about the changes in rules of free allocation for phase four. So while their need for ellu might decrease because of the slowing economy, at the same time, they also expect to receive less free location. And the question is where the balance is in the future. But I have to say that industrial installations have not stopped buying just because they see their production levels decreasing, because most of them keep an eye already on the future and they prepare for compliance in phase four.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 9:25

And an additional factor here. Or a very important factor to watch out for in, in the coming months and years, nor is the German coal exit last week. Not just the

Nora Kamprath Buli, Editor Germany, Montel: 9:35

German one, I think, but the general European one. Certainly.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 9:38

But, but, um, you know, I think we could focus a little bit specifically on Germany at the moment because. We had some more details come out last week in particular regarding carb markets. Wouldn't you say that was the, the move towards

Nora Kamprath Buli, Editor Germany, Montel: 9:53

developing? Yeah. It's not so much linked directly to the coal exit, but the climate package that Germany presented they have now opted for sort of model where they would implement a national ETS for sectors not covered by the EU ETS, which I guess doesn't really affect. The deal of EETS, but at the same time, they also released a statement that they would support some sort of minimum price or, or carbon flow for, for the EU ETS to, to prop up, uh, prices there, I guess in the events of downturn or just to make sure that, you know, we, we continue to see decarbonization. So I was wondering actually about that effect that Germany is now supportive and, and what kind of shape could such a, yeah. Price take, um, in combination with other countries or, or has Germany's position changed on this? And

Bernadett Papp, Senior Market Analyst, Vertis: 10:45

what does it mean for the market? It is very interesting because I think that expectations, uh, before the announcement of, of Germany's climate plan for 2030 were quite high. So before last Friday, and then the reaction in the carbon market was missing. I think. Market participants expected either something more bold to be announced because we really haven't seen any price effect in in the carbon market, or we are missing some details. You know, in, in, I think that from the perspective of the E-U-E-T-S. Uh, what is more important, maybe more important than a price floor, is the, the closure of the coal fired power plants. And we, we still miss many important details about that plan.

Nora Kamprath Buli, Editor Germany, Montel: 11:39

Yes. I think the planning maybe more information, but you follow this.

Marcus Ferdinand, Head of EU Power and Carbon Analytics: 11:44

Yeah. I, I don't, I think the market has any more information than what was in these 22 pages that the government released, right? Mm-hmm. I mean, it's, in a way, I think the climate package, as it was as it was adopted in terms of government conclusions, doesn't entail any change to the EUTS, besides the announcement to maybe do something in the future which requires the help of. A lot of other member states basically to become true, right? So in the end, there is, there is a political vision to first create the non ETS trading scheme, then link it at some point to the EETS and before that introduce a a minimum price in the ETS. So yes, you can, you can create a domestic ETS for non. Traded sectors, that's not a problem. Um, well sparing out all the legal details, which are still like unclear, right? Especially with the fixed price element in there. The linkage to the UTS is a completely different game and you need support in parliament and from member states in council to do so. The minimum price, exactly the same thing. And there will be fierce opposition by a lot of member states to actually introduced that. So overall I think. For the moment, this is a bit shifting responsibility away again from Germany to like the European level without being able to guarantee any, any action.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 13:01

But isn't it quite an interesting step for Germany to put that forward?'cause it's always been very. Vocally opposed to it. Yes. There has always been a focus more on balancing supply and demand rather than focusing on price.

Marcus Ferdinand, Head of EU Power and Carbon Analytics: 13:11

Yeah, I, I totally agree to that. I mean, first of all, I was surprised to actually see the the president elect of the new incoming commission fund line to announce that kind of plan, which in a way seemed to be a bit rushed. So that's kind of, that's the increase of the 2030 targets. But also the ideas around introducing potentially a minimum price or including transport and, and residential in the UTS knowing that she comes from Germany, I'm quite sure that yeah, there are some behind the door talks that have kind of led to that statement. So this is now followed by the German government, um, which indeed is a change in the policy approach. Um, so that's gonna be interesting to see how Germany actually plays it. Um, how also Germany plays it in light of the announced coalface out. That's also still needs to be put into legislation hasn't been done yet. And the discussion there around, um, the cancellation of uas in relation to the coalface out and the upcoming MSR review, where Germany also will need to take a position whether or not, to support the strengthening of that mechanism. So all of that I think, plays well together. With the announcement of the potential introduction of a minimum price in the UTS. Mm. So I think all of that has to be seen together, which could hint towards the interpretation that Germany's not that much interested in canceling uas, but rather kind of moving into, uh, one of the two other directions.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 14:34

If you could just explain the canceling of uas, because as, as you close coal fired generational coal fired plants. The uas that they would previously need could be canceled. I mean, there's a provision in the, in the directive isn't there, that that member states may, so it's all voluntary. And from what you're saying there, mark, is it seems to indicate that Germany's not going to go that direction. That's an interpretation.

Marcus Ferdinand, Head of EU Power and Carbon Analytics: 14:58

Yeah. First of all, this is one of the possible interpretations, so I'm not, I'm not saying that this is going to happen with regards to the possibility of canceling uas. So as you said, this is part of the ETS directive as of 2021, when a member state closes kind of fossil generation assets, the member state is is able to cancel the equivalent amount of allowances. Basically to to balance for the reduced emissions. I would say there still is not a percent clarity on how this mechanism will work. How much UAS can be canceled to at the maximum whether that's across or net emissions that will be canceled. So do you account actually for kind of replacing energy in terms of like f firing up gas turbines to replace. The, um, lower generation in Ignite assets, right? Which obviously would then increase a little bit the emissions again. Um, so all of of that is, is unclear. Um, and I think this is something where I have seen the recommendation of the, the Expert Commission Germany, which basically recommends to cancel the maximum amount of allowances in order to basically neutralize the effect of the German coalface out. But so far we haven't heard. Anything besides of the environment ministry, anyone besides the environment ministry, like saying that they want to make use of that mechanism, which obviously makes you wonder in this context of the wider energy and climate package. There would've been a good opportunity to clarify on that and policymakers basically didn't do that, which to me shows that there is still quite a high controversy behind the doors with regards to that matter. And I mean, looking into the impact on prices and, and on the market. It's hugely important basically to have clarity on this because it will have quite an impact on the demand supply balance really, depending on which pathway is taken, whether that's the striking of the MSR. If this is an option for the German government, yes, it might increase its chances for more aggressive system more aggressive mechanism for the second half, phase four, whether that's cancellation, which is really like a domestic measure that a member state can take. So Germany would be. Able to respond to its own policy and neutralize the effect, or whether that's the really big push for the introduction of a minimum price, which I see very skeptical in the current political environment.

Nora Kamprath Buli, Editor Germany, Montel: 17:11

What could you expect, let's say Germany were to announce that they are not canceling those allowances are we talking about all of a sudden a massive drop in in the in, in carbon prices or.

Marcus Ferdinand, Head of EU Power and Carbon Analytics: 17:24

First of all, they have to to announce how they're going to cancel the the power plants. So I think this is the first so the pool of

Nora Kamprath Buli, Editor Germany, Montel: 17:29

power plant come is more important, I guess. Well,

Marcus Ferdinand, Head of EU Power and Carbon Analytics: 17:31

that's the first step, right? But then, you know, in a way the bearish impact on the markets.

Nora Kamprath Buli, Editor Germany, Montel: 17:35

Yeah.

Marcus Ferdinand, Head of EU Power and Carbon Analytics: 17:35

And then the next step would be to announce how. And if they're actually taking countermeasures in terms of strengthening et ts, in case it remains as vague as, yes, we want to have a minimum price at some point and maybe do this or that. I would certainly see that as bearish. Yeah. If there is an announcement to cancel the equivalent amount of allowances I would say it could be mildly bullish. I think at the moment the market takes it as. Neutral, wait and see having a notion that Germany's going to do something, but not exactly knowing what, is

Richard Sverrisson, Editor-in-Chief Europe, Montel: 18:04

there an appetite for canceling the UAS elsewhere? I mean, I, I have any member states come out and I, I, there were some positive noises perhaps from Sweden.

Bernadett Papp, Senior Market Analyst, Vertis: 18:13

Yes. Nordic countries were, lets. Say, leading with example. By announcing willingness to cancel allowances that are not necessary by, by the closed fossil fuel power plants. But of course we have to differentiate between the extent. So in the case of Germany the number of NCS to be canceled then is significantly higher. And one important aspect is that. Germany really tries to introduce ambitious policies in order to achieve its 2030 targets. But to be honest, these have to be financially supported somehow. And auctioning allowances can be a nice source. Of financial resources. So in my reading, what Germany is doing right now is just listing options. It'll choose from in the future.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 19:11

So that, what I mean remains is huge amounts of uncertainty and, and we need to have to see the details before we can take a, a positive view or details

Bernadett Papp, Senior Market Analyst, Vertis: 19:22

will be essential.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 19:23

Yeah.

Bernadett Papp, Senior Market Analyst, Vertis: 19:25

Autumn

Nora Kamprath Buli, Editor Germany, Montel: 19:26

and we've got the announcement from Germany, which is expected

Marcus Ferdinand, Head of EU Power and Carbon Analytics: 19:30

by the end of the year. Let's not forget that. It seems to be super hard at the moment of Germany to actually come forward with any like very directional statements in terms of any policy given the ground coalition that we have. So that is something I think which also hinders a little bit like the possibility to take a very. Direct statement or, or any, any like concrete, uh, direction. And there, I think it's really interesting to see how well the next federal elections, I mean, there are still a bit of a wave, but it's it's something where we see that with the current kind of call for more climate action and, and more sustainability, the greens have, have strengthened extremely, I mean, on the one hand and the right wing on the other hand, like taking, fishing up all the, the protest, borders. So I think like with the next election, we might actually have a complete different picture in Germany with regards to how the government looks like, or at least having another party in the government that might push the government into a much more directional way. Compared to what the Grand Coalition is currently being able to do.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 20:28

So we might have to wait a few more years yet for, for further clarity on this issue.

Marcus Ferdinand, Head of EU Power and Carbon Analytics: 20:33

Yeah. That, uh, makes the life as an endless always enjoyable because you always have work for the next few years. Exactly. And for something to talk about on

Richard Sverrisson, Editor-in-Chief Europe, Montel: 20:39

this podcast. But anyway, thank you. Thank you very much to my guests, Marcus, Bernadette, and Nora. That's all for now listeners. You can follow all the latest news on montel news.com and you can follow us on Twitter and LinkedIn and subscribe to the podcast on Spotify and Apple Podcasts. Thank you very much for listening. Goodbye.