Carbon set for green deal boost

European carbon prices will strengthen as the 27-nation bloc tightens its climate ambitions over the next 18 months. 

However, prepare for market volatility in the short term amid Brexit, low gas prices and uncertainty over Germany’s coal exit. 

Host: 

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

Guests: 

• Tom Lord, Head of Trading and Risk Management, Redshaw Advisors, 
• Alessandro Vitelli, Carbon Reporter. 

Transcript

Richard Sverrisson, Editor-in-Chief Europe, Montel: 0:04

Hello listeners and welcome to the Montel Weekly podcast, bringing you Energy Matters in an informal setting. My name is Richard Sverrisson. Listeners, if you are wondering what to make of the latest news coming out of Germany or what's happening with Brexit in terms of what it means for the carbon market, then you've come to the right. Place because today in a carbon special, I'm joined by Tom Lord of Redshaw Advisors. Welcome to you, Tom.

Tom Lord, Head of Trading and Risk Management, Redshaw Advisors: 0:29

Thank you Richard.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 0:30

And my old pal, Alessandro Vitelli, who's been covering these markets since the 1890s. Isn't that right?

Alessandro Vitelli, Carbon Reporter: 0:35

Greetings? Yes. 1880s.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 0:37

Perfect. So warm. Welcome to you both now, I hope 2020 has been good to you so far, Tom.

Tom Lord, Head of Trading and Risk Management, Redshaw Advisors: 0:43

Yeah. We've been been busy. Yes, indeed.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 0:45

Okay. And for you Alessandra.

Alessandro Vitelli, Carbon Reporter: 0:46

Yes. Lots of work going on.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 0:48

Perfect. Now let's start by discussing current market prices. We've seen prices continue in a range of 24, 26 since we last spoke, which was in November, if I remember right. Tom? I think so, yeah. So what are the main drivers at the moment? What can you talk us through those please?

Tom Lord, Head of Trading and Risk Management, Redshaw Advisors: 1:04

Yeah, it's it's a little mixed at the moment. There is an overriding, bearish, fundamental outlook, I guess. Um, we have gas prices hit. New lows on almost a daily basis across Europe. The clean dark spreads are at the lower end of the second half of 20 nineteens range. We have the return of the UK auctions at some point. We dunno exactly when yet, but at some point they'll be coming perhaps towards the end of Q1. And we've had a mild winter so far. Apart from a few days here and there, winter has been quite mild. On the other side of that, we are coming into compliance buying season. So, um, there are a number of companies across Europe who buy their carbon once they have their verification reports in hand. And they buy it once a year. And obviously the deadline at the end of April means that those guys are now now starting to filter through.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 1:53

For those listeners who are unaware of what the clean, dark spread is, that's the profit from generating coal at coal fired plants Vitelli. Would you concur then that the situation's pretty bearish

Alessandro Vitelli, Carbon Reporter: 2:02

fundamentally, that's the only conclusion you can really reach. You look at the supply situation, you look at the likelihood of the UK volumes coming to market. You look at the continuing uncertainty over the German coal phase out and what that means in terms of cancellation of EUAs. We have no real. Definite idea yet. You look at the mild weather, you look at the extremely high levels of Nordic power reserves and the hydro system. All of that points to, you know, a long market. And until we get a clear steer on what Germany's gonna do, until we get a a sense of how gas is going to evolve over the coming 18 months, I think we're in this. What'd you call it? Contrary market.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 2:41

I think there are a number of factors here, which we'll return to, but would you then agree, Tom, that the market sentiment is fairly bearish, but prices seem to be bearing up around, you know, in this 24, 26 range?

Tom Lord, Head of Trading and Risk Management, Redshaw Advisors: 2:55

Yeah, I agree. I think. I would say market sentiment is almost a little mixed. It seems seems amazing to say that given that we've just listed off a whole lot of bearish fundamental factors, but I think with the carbon market, the short term outlook is bearish, but the mid to longer term outlook is a lot more bullish. And I think that. Creates almost like a conflicting bull. And I think it also raises the question mark around investors and the way they are interacting with this market. So we saw a lot of investor interest in 2018 when prices prices move materially higher. And then 2019 was probably the liquidation of much of that interest. So the question mark is what is waiting in the wings investor wise and where and when do they come back in? So the, I think. Yes, there is. There is the chance that the EUA price falls through the first half of this year, but the longer term outlook is certainly one of higher prices.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 3:48

And what would spur the return of these investors in your view?

Tom Lord, Head of Trading and Risk Management, Redshaw Advisors: 3:52

Very difficult to say really? Because they play in the shadows, I guess is is fair to say. So not. That much is known about them in terms of the way that they interact with the market. The influence through 2018 was obviously very pronounced. The price trebled across the year. And whilst I'm not necessarily saying that will happen again, I do think that there is a lot of interest waiting in the wings to get back into the carbon market. Now, I think if they're looking at the outlook there's the chance that we get lower prices, but that may well find they, they may well be sitting at. At those levels waiting to buy. So we could find that there is there is good support for carbon at lower levels, not just from compliance buyers, but also from investors looking to get back into this market.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 4:32

Sure. So you mentioned the UK auctions. When can we expect clarity about you know, 20 19, 20 20 volumes?

Tom Lord, Head of Trading and Risk Management, Redshaw Advisors: 4:40

Uh, the age old Brexit question, I guess. Exactly. Yeah. It's getting a bit boring now. When can we get clarity? Yeah. So, The UK government will have to discuss the auction calendar with. The European Commission, as far as we are aware, that cannot take place until all of the procedural, hopefully formalities are out the way, but obviously we're still waiting for that. So once the withdrawal bill is ratified into UK law and. EU law, then obviously you the talks can progress exactly how quick the UK auctions will return. Once that happens, it's very difficult to say. Our suspicion is, it'll probably be nearer the end of Q1. Okay. It could be earlier, but obviously the calendar has to be agreed. Then the market has to be given notice and then the auction starts. So, and we're fast moving through January. As we as we speak, absolutely.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 5:26

Is this a view you share? Alessandra?

Alessandro Vitelli, Carbon Reporter: 5:28

The UK auctions are the short term drivers of supply that everyone is waiting to hear about. It may well be that in the absence of anything concrete, in terms of decision on dates and volumes, the market's holding fire, and that's why we're stuck in this 24, 26 range. When that information comes out and it looks more and more likely that the volumes will be. Spread over the course of the rest of the year. That's actually a supportive signal because it doesn't concentrate any volume in any short period of time. That may be a relief signal a catalyst moment in the market where people say, okay, we're not gonna be flooded with e Uua. It's gonna be a drip feed across the rest of the year. Let's think about maybe starting to, you know, take, take positions. It's a real matter of waiting for, for the actual truth. I, the decision. I think it's an interesting sign because. People have traditionally in the carbon market, jumped all over indications of something happening and sold or bought the rumor or the early news. And then when the fact arrives they've done the opposite. I think people are waiting because we just don't know exactly what the timetable's going to be. And when we actually know the timetable, then we can we'll see a reaction.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 6:38

Absolutely. So the market will e we eagerly awaiting clarity on that as it has been waiting for quite some time. But how do you both see the market playing out for maybe, you know, beyond Q1 and Q2 and, and the rest of, uh, you know, the rest of the year? Um, Alessandra, I know that you conducted a recent Twitter poll. Can you, can you say anything about this any surprises there?

Alessandro Vitelli, Carbon Reporter: 6:58

The poll that I carried out was sort of just general and democratic and open. I didn't have any reservations on who could participate, so I had a lot of traders get involved, all obviously on a confidential basis. And they are noticeably more, I think, bearish than the analysts were. And I think they, you know, a lot of these guys are looking at gas with one eye, looking at power with the other, other eye and then looking at carbon afterwards, and they're saying, well, I don't see any supportive signals from the fundamentals. And I think that's a, that's something we're going to see throughout the year. Gas isn't going anywhere. You know, people are talking about the supply even increasing this year from the us and if that happens, then there's no reason really for gas to go up unless we have something strange happening to the east. As a consequence, there's no supportive signal from, for carbon, from the power complex. That is what these guys are, I think are reacting to the analysts are looking more in terms of, you know, pure supply demand, the operation of the MSR, the German cancellation and various inputs on a more sort of political slash regulatory basis. And I think somewhere between the two I. The truth lies.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 7:59

You said they would largely bearish the traders. Can you give us a sort indication of, of the, the spread?

Alessandro Vitelli, Carbon Reporter: 8:05

Sure. I mean, I had, I had a range that went from at the high end, 65 euros as the closing price on December the 14th, which is the expiry of the contract right the way down to 1750. Okay. So you have quite a wide variety. The average of that was 28 80. Which is noticeably lower, I think, than some of the analyst polls that we've seen and heard about, which are looking prices more like, you know, sort of 28, 29, in some cases, a range as high as of, you know, 30.

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

So what's your view here, Tom?

Tom Lord, Head of Trading and Risk Management, Redshaw Advisors: 8:35

I think, uh, we're gonna see some, some bearish pressure in the first half of this year, certainly, but I think as the year progresses. There will be potential for upside. I, I guess the question mark is from what level that upside starts. So if we've fallen all the way to 17 and get 10 euros of upside, we're still only back to 27 by the end of the year. So I think a lot will, will depend on just how low gas prices go and how much of that fuel switching is priced in. But it certainly looks like the first half of the year where we're gonna see a lot of pressure on prices. But then as I say I think. 20 21, 20 22. The draw of higher prices is likely to see interest in this market. Whether that's when the investor's looking to get in the second half of this year, perhaps, very difficult to know, but I certainly think by the end of this year we will be, we'll probably be looking higher rather than lower.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 9:27

Are there any other fundamental factors to keep an eye on? We mentioned. Gas we've mentioned, you know, the Brexits, I think we'll, we'll, we'll talk a little bit about the German coal exit potentially, but I'm thinking also, uh, around the, you know, the, the green deal, once details of the European Commission's, green Deal emerged, how do you think this will play out in, in, in the carbon market? Will it be very volatile? Will it, you know, will it react to certain tweets or noises coming from politicians or will it, you know, will people wait and see what. Until the details emerge. What, what do you see happening here, Tom?

Tom Lord, Head of Trading and Risk Management, Redshaw Advisors: 10:01

I think probably because of the timelines, it won't be quite so sensitive, so I don't think I don't think necessarily tweets are gonna be moving the market, but it, the green deal is huge. It's a, it's a big development. It the 2030 target in particular, so increasing that from 40% to 50 to 55% has. Massive potential implications for the UETS. Obviously, we don't have any we don't have any concrete proposals yet with which to work with, but it looks like the linear reduction factors of the speed at which the cap falls will have to increase substantially to meet those targets in the UETS.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 10:36

These are details that. You know, will emerge in the coming months, potentially in the run up to 21, 22. So Alessandro, you're gonna say. Yeah.

Alessandro Vitelli, Carbon Reporter: 10:44

And in, in terms of the impact of this screen deal, you have to go back and look at how the MSR proposals evolved over time and when the market reacted to them as well. The MSR was known about for a good 18 months to two years before it actually was approved in the EU at the very end of 2017. And it was only really in that last quarter of 2017. When the ink was about to be placed on the paper, the prices actually started moving. So we have a long way to go before the Green New Deal. In all its various forms in all the various areas where it's going to impact us. We'll be elaborated, discussed, debated, approved, amended, and then finally taken to the European Council. So I'm not looking for this for another 18 months minimum. Maybe even two years minimum before we start seeing the final form that it's going to take. And then I. All the knock on impacts in terms of reform, the E-U-E-T-S. So I think you can forget about that for 2020 for sure. In 2021, you start keeping an ear on what's going on in Brussels, and then maybe towards the end of 2021 you start thinking, okay, this is looking a bit more solid. Now we can start planning.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 11:48

So the similarity, as you say, would more likely be with the market stability reserve rather than the back loading issues? Yeah,

Alessandro Vitelli, Carbon Reporter: 11:55

it's the same process, the same political process of a proposal, a debate. Parliament, committees, amendments, et cetera, et cetera. And Tom? Yes. What's your view? I

Tom Lord, Head of Trading and Risk Management, Redshaw Advisors: 12:04

think I, whilst I agree with that, I think the difference is that the MSR, there was always a lot of doubt as to whether it would ever get through, whereas the green deal by the fact that every member state bar one has signed up to it already. Obviously, though, those, the proposals have gotta actually be fleshed out now, but the fact that there's buy-in from everyone, bar one member state. Suggests that this is happening one way or the other. Whereas the MSR until the signature was on the dotted line was was very much in the balance, I would say. So I think you maybe get more of a, as we start to get the details through, we maybe get more of a draw to that. And I think. The writing is on the wall with carbon prices across Europe, not just for those in the UETS. Absolutely.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 12:45

Also, in recent weeks, we've seen a lot of news and noise and maybe some confusion coming out of Germany. Now they've announced closures. They've also announced that a new. Ultra modern coal plant will come online. How they compensate for that will be interesting, but what are the implications for the carbon market here, Tom? Have you looked at this in any detail? I think you know, the details around sort of cancellation of carbon allowances. There's not, they're not really there yet, but what's your view?

Tom Lord, Head of Trading and Risk Management, Redshaw Advisors: 13:13

Yeah, so we're still, I mean, we're still awaiting the, the final agreement, which I believe is the 29th of January. I think we're. We we get that as we understand it, the cancellation will be will be sizable. I think the key issue in terms of cancellation is the timing of that cancellation. So if you have coal plants shutting and then the cancellation isn't till the following year, the net effect may be zero in terms of the e uua over spill. But obviously you have one year that's long, and then the next year the cancellation takes place. So that will potentially drive volatility in the market. But obviously we need to see the final plans before you can really get a good grip on how this will all play out. Alessandra, what's your view?

Alessandro Vitelli, Carbon Reporter: 13:54

Well, I still think there's a few details that we need to understand. I mean, there's still confusion as far as I'm concerned, over the language regarding how many years worth of allowances are going to be canceled. There is mention of the equivalent of five years average emissions being canceled, and for a plant that start that, that stops in 2022, if that means that the next five years worth of that demand is canceled, you, they come back in 2027. Does this, does this apply? Go back up in 2027 or 2028 or not, are these eua canceled every year in perpetuity until there is a recalculation of the overall cap? It's not entirely clear to me what this represents in terms of a permanent removal of EUAs, so I'm still a bit skeptical. The details have come out. They've contradicted themselves that they've been added to subtracted from. I'm not yet ready to take a view on this.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 14:45

And I think, you know, maybe it's unlikely that all the details will be clear, uh, on the 29th as well. I think, you know, this is, this is gonna be something that's gonna keep developing and, and, and, uh, you know, the ball will keep rolling. I agree with Alessandra.

Tom Lord, Head of Trading and Risk Management, Redshaw Advisors: 14:57

I think there is still a lot of uncertainty. I. We simply don't know the details yet, and therefore it's very difficult. And there, there has been a certain amount of flip-flopping, I guess, um, between the things that have leaked and it makes it then very difficult for the market to, to know what may happen. And I, I guess that makes people nervous in terms of their interaction with the market. You don't want this to. This news to break and it be completely different from what you're

Richard Sverrisson, Editor-in-Chief Europe, Montel: 15:22

expecting. And I think the political situation, again, if I'm not completely wrong, could change in Germany as well. And you could get a lot of grassroots pressure, you know, calling for an earlier closure, which would then change the picture fundamentally yet again. On the 1st of April, we'll get some figures concerning 2019 emissions. Tom, what do you expect to see here? Will we get a large decrease? Will it be flat?

Tom Lord, Head of Trading and Risk Management, Redshaw Advisors: 15:46

We think power emissions will be down. Industrial emissions, more or less flat, probably slightly lower, but more or less flat. But certainly the power sector. There was. Fuel switching, taking place through 2019, and without doubt, power emissions will be down, I think.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 16:01

How about, how about

Alessandro Vitelli, Carbon Reporter: 16:01

you, Alessandro? Yes, I mean, the, the, the numbers from Germany, I've, I've seen figures thrown around up to 15% reduction in emissions, year on year from the power sector. If that's replicated across most of Europe or a lot of Europe, then that's quite substantial. Industrial emissions, there's been no warning flags thrown up about industrial production sinking rapidly. So. If there's a small decrease, then that's probably within the expectations. I don't think anyone's expecting an increase in emissions from last year. So that's off the table. It's just exactly how much they fall. Will it be the biggest decrease ever? You know, we've got a, a big. Chunk of that being contributed by the, the power sector. So that's, I think the scale of the, of, of the decrease that we're looking at. 15%. Well, I've heard some numbers that, that, that, that show some big, big decreases. Yes. Over the course of last year, with especially the second half of the year, having seen wholesale switching, there's some big numbers there. I've also under understood there's still gas capacity in Germany that remains to be switched on. So if gas price keeps going, if power price, you know, holds reasonably stable. Then there is an incentive to move the remaining gas capacity onto the market and, and, and take call out. So. There's more switching to be done and that could even drive another decrease in 2020. We'll just have to wait and see how it turns out. But yeah, I've seen some big numbers.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 17:20

Tom, when, when we last spoke, you mentioned that, you know, some companies may not fully realize the cost of becoming carbon compliant IE meeting their obligations under the EU ETS. Has this changed since we last spoke?

Tom Lord, Head of Trading and Risk Management, Redshaw Advisors: 17:32

No, I don't think so. I think. The UETS is one, one part of carbon costs that companies now face, and the green deal will only increase that. So I think there is whilst a lot of companies don't necessarily understand their EU ETS exposure fully, it's also a total carbon cost that I think people are wildly underestimating. So, as I say, the, the green deal is huge. It will drive carbon costs across Europe for every business higher. Not just those in the UETS we've seen, since the cop 25 failure, I guess you could say with Article six, we've really seen businesses picking up the kind of mantle on that. We had Microsoft the other day with a 2030 carbon negative target, I think it was. And there, there's been a, there's been a whole load more, and I think the risk companies face is not only higher carbon prices, but also being left behind in their respective markets. If competitors are looking at carbon neutrality, renewable electricity, the trends are changing. Investor and consumer. And I think there is a big risk to all companies across Europe if they're not proactive in tackling this carbon cost that they are, they're

Richard Sverrisson, Editor-in-Chief Europe, Montel: 18:35

gonna face. We talked briefly at the beginning about gas prices being one of the drivers here, and we've also mentioned that, you know, they look set to continue downwards, especially now that the deal between the ru between Russia and, and the Ukraine. How will this impact carbon Tom? I mean, will this lower demand for EUAs and then. Potentially also lower prices?

Tom Lord, Head of Trading and Risk Management, Redshaw Advisors: 18:55

Yeah, certainly. I mean, Alessandra just touched on that in terms of the amount of fuel switching that took place in 2019. And there is still to some to come. So we have high supply, relatively low demand, especially with the winter having been so mild so far. We look set to head outta winter with record high levels of storage across Europe. I guess the big question mark is potentially the summer. Where does it all go? If storage is full, this gas has to find a home somewhere. And that points to prices. Falling even further, perhaps a lot further, you're then in fuel switched territory everything utilized that can be utilized from the gas market

Richard Sverrisson, Editor-in-Chief Europe, Montel: 19:33

because there is a limit to what? I mean you can't switch everywhere and you know, all, all gas plants. I mean, you mentioned the gas plants earlier, Alessandro. Do you expect to see every gas plant in Europe fully utilized Should prices fall that low?

Alessandro Vitelli, Carbon Reporter: 19:44

Well, it's possible. I mean, it, it is one of those statistical. Calculations or I don't know what you'd call it. You have to go out there and investigate and find out exactly how much plant is running. And, you know, I had some, I, I've heard people say that I'm think in German there's about three gigawatts of gas fired capacity that's left to come online. So there's still some potential switching to be done. The question is, what happens when you get to the maximum practical switching? Uh, you still have an armada of LNG ships coming from, you know, east from the us. They're already flaring huge amounts of gas. In, in, in, in the basins. Um, so, and they're still exporting. Where, where do we rescue that? So that, that flared gas from, 'cause that's bad news. You then have to think about, you know, Asia alternate markets. Where's that gas gonna go? Uh, you know, is Asia able to take it? And if not, are they gonna start shutting in production? Because some of the numbers the, you know, the production costs and margins for us gas producers now are critical. And some are talking about shutting in production and some are suffering financially as a result of all of that. There could be in some, in one sense, a quite rapid turnaround.'cause if Henry Hub Gas just keeps going down, it's below $2 I think, right now. And it risks going further down. There could just be a wholesale switch off of production in the States, and once that happens, the turnaround in the European market will be quite rapid. I would imagine. Traders will not want to be caught on the wrong foot if suddenly there's no more us LNG being being, being sent out. So I think. That's one thing we keep a really close eye on.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 21:12

And I think that's maybe another topic for a separate podcast as well. Alessandro, thank you for that. It's a pleasure to have you both on the pod and I hope we can discuss these issues again or revisit them later in the year. So thank you very much, Tom, for joining the Monte Weekly podcast. Thank you for having me, and thank you, Alessandro.

Alessandro Vitelli, Carbon Reporter: 21:28

It's a pleasure.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 21:30

Remember to keep up to date with all our stories on Montel News. Follow us on Twitter and LinkedIn and subscribe to the Monte Weekly podcast on Apple podcasts and Spotify. Thank you and goodbye.