Rogue carbon trader?

This week’s pod focuses on the carbon market and, in particular, the reasons behind the price spike in mid-July. Was it due to the closing of a speculative position that went rogue, or were other fundamental factors at play? 

Tune in for a discussion on the outlook for prices going forward, the potential impact of the EU green deal and the UK ETS post Brexit. 

Host: 

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

Guests: 

• Louis Redshaw, founder and CEO Redshaw Advisors, 
• Alessandro Vitelli, Carbon Reporter. 

Transcript

Anna Siwecka, freelance journalist/podcaster: 0:01

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Richard Sverrisson, Editor-in-Chief Europe, Montel: 0:35

Hello listeners and welcome to the Montel Weekly Podcast, bring You Energy Matters in an informal setting. This week we'll be talking about the carbon markets. What's driving prices in the EU ETS at the moment? What's the direction for prices this year, and how could a green recovery in the EU impact prices? And last but not least. What system does the UK plan to have in place for when it leaves the eu? My name is Richard Sverrisson, and for this week's episode, we are very fortunate to have two carbon market veterans. Firstly, Louis Redshaw, who has a long career in energy trading and has been covering the EETS since its inception. He is the founder and CEO of Redshaw advisors, carbon market experts. Also, joining us this week is my old pal, Alessandra Vitelli, who's been covering the market since the 1880s. A warm welcome to you both. Good morning. Good morning. I think we'd start off by talking about prices at the moment. What's currently driving the market in your view, Louis?

Louis Redshaw, founder and CEO Redshaw Advisors: 1:38

So we've got a number of factors. Conspiring at the moment. There are quite a number of bearish factors. We have additional auctions this year from the UK that wasn't able to auction EUAs last year. We've got additional EUAs being auctioned by the innovation fund. 50 million EEU allowances are coming to market this year. We have the virus of course, and that's impacting electricity demand as well as having impacted factories earlier in the year and to less of a degree. Now. And we have continued growth in renewables capacity, and we've got low gas prices. All in all, the ability for carbon to go higher should be muted. The flip side of that, though, of course, is the market stability reserve. That sucked out a lot of volume and we have had an interesting development in the last month, which was in Portugal, having to buy back by our calculation, at least 10 million e allowances due to some. What they term rogue trading. And we've also got the situation at the moment with August having halved levels of auctions, which is a familiar feature to those trading that in the. Whereby the European Commission determined that because pretty much everybody goes on holiday in August, that the market doesn't need as many EU allowances in the auctions in August. So they did half the volumes arbitrarily. And what that has caused in pretty much every year since they've done that is for prices to go up in August. And that was every year except last year. It's a bit a toss of a coin this year.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 3:12

Would you concur with that? Alessandro? Have we found a sort of range at the moment between sort of 26, 25 euros?

Alessandro Vitelli, Carbon Reporter: 3:18

Yeah, for the last, what, two or three weeks? The market's been sideways effectively between anywhere between 25 and 27 50. We're drifting a little bit. The past couple of days has been some bearish tendency. I'm thinking that we are at the height of the holiday season, perhaps this week. And that activity is going to find its lowest debt this week. After this, people will start drifting back. There'll be some anticipation of what happens when everything resumes in September when normal activity resumes next month. And when we get the new auction volumes coming into the markets adjusted by the MSR. Which itself is based on the tac from last year.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 3:53

What's the outlook for the rest of the year, do you say? Listen, what are gonna be the key drivers?

Alessandro Vitelli, Carbon Reporter: 3:57

I think the main thing hanging over everything is whether or not we get a real second wave of the pandemic. And whether that is, has a real impact on economic activity at lockdowns. That's the real, I think, crux for the rest of the year, I think in terms of market sentiments. We've already shown with the rally that we went through after the big drop in March, that the market has the ability to look further forward and to a adjust prices on the basis of that. They're looking at the green deal. They're looking at the 2030 adjustment of the target. They're looking at the app operation of the MSR, and that's what took us back to where we were before the COVID selloff. Therefore, I would expect that to be a continued factor. What will change will be the attitude of speculative players based on the impact of a possible second wave. And then people are gonna start thinking about verified emissions for the whole of 2020, which aren't looking particularly bright as we know. So you may see, I think, some weakness in the second half of the year. As people look at the practical fundamental to de demand supply balance for 2020,

Richard Sverrisson, Editor-in-Chief Europe, Montel: 5:07

we've talked a little bit, me and you last week about sort of the gas price rally and the pen potential impact of a reduction in nuclear availability. Are those gonna be drivers at all? As

Alessandro Vitelli, Carbon Reporter: 5:18

far

Richard Sverrisson, Editor-in-Chief Europe, Montel: 5:18

as

Alessandro Vitelli, Carbon Reporter: 5:18

I'm concerned, yes, but I think the nuclear availability question. It was an issue maybe three, two or three months ago when it was first announced. It's being refined steadily with every new announcement that EDF make about their shutdown schedule. But I think the market will have taken that into account. We have very strong renewable supplies this year as the data shows us, and I think the adjustments that go that we get going forward will be marginal. And therefore they won't have as big an impact on prices they might have done before.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 5:48

Lewis, would you concur with Alessandro's view here that when we get into the autumn, market participants will be looking more to what's happening in the green deal and to maybe to 2030, which will drive price, invest of the year, as well as. Fundamental factors.

Louis Redshaw, founder and CEO Redshaw Advisors: 6:03

Yeah, I mean it's it's a bit of a mixed bag at the moment. So I think the most significant point to highlight is the fact that the price today is higher than it was before COVID set in, as it were in March. So the market corrected towards, mid, towards the end of March in quite a big way. And that looks to me to have been something of a panic sell by participants in the market. And then it recovered a whole lot more and we hit. 13 year high. 30 euros just a month and a half ago. So there's something quite weird going on. So I've mentioned the Gallup energy buyback, but the thing we haven't talked about is the options market. And clearly in my mind there is, has been a lot of options Delta hedging that has created something of a positive feedback loop that has caused the price to go higher and higher as those option call option sellers have been buying back the underlying to hedge themselves. The question then is what what do we get in the second half of this year? As Alexandro points out, we've got more auction. September is the highest auction month this year. So far, the whole year we've had more auction than we had last year. It's perhaps slightly confusing that the prices is so high, but as we get towards the end of the year, those options buyers and those speculators that are trying to make a profit from a rise in prices, they're gonna have to sell back the underlying. So we've got a lot of moving parts. Then of course 2021 and it's a new a new game again, we have nuclear closures. The MSR starting to really bite no additional UK auctions. In fact, the UK coming out of the EU E ts will cause the EU e ts to be a bit shorter than it was expected. So we've got a bit of a rollercoaster coming up, and most analysts are pointing to higher prices next year.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 7:49

Okay. What and the rest of this year, Lewis, do you think we could return to the 30 euro level?

Louis Redshaw, founder and CEO Redshaw Advisors: 7:54

That's a very good question. My bias is to the downside, based on the fundamental. The thing that surprised everyone else and us in the market just a couple of months ago was the strength of that rally that is demonstrating there's additional buying interest. Could it all be, rogue traders and a couple of people that have gone a bit too short because of COVID-19 probably. But there is a lot of talk of interest from other parties in the carbon market. Bearing in mind the EO ETS is perhaps one of the only sensible hedges that companies can make. Against higher carbon taxes and prices in the future. At the moment. And the e ET is very small, so you don't need a lot of interest from outside of the EU ETFs outside of Europe, even for that influence to be felt now 26 euros, it's not a particularly compelling trade, but if you believe some of the forecast for next year that are, that 35, 40 some even higher, then it could explain some of the strength we've seen in recent months.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 8:54

You would put it down to the options trading and also to potentially the gout. Be McGee, position here that there's the main drivers behind the 30 euro spike rather than fundamental factors.

Louis Redshaw, founder and CEO Redshaw Advisors: 9:07

Yes, I'd say so. Got a, quite a tightly balanced market at the moment because of the mss. We tend to see so 10 million tons doesn't sound like a huge amount, but if it's 10 million tons, the market wasn't expecting and depending on how quickly they bought that back, it's gonna tip the market out of balance and of cost other people to take actions that they wouldn't ordinarily have taken. It's sensitive to the large, larger size trades, shall we say.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 9:30

And Alessandro, is this also what you are hearing in the market about this 30 euro spike in July? Yes. So it was,

Alessandro Vitelli, Carbon Reporter: 9:36

every action has an opposite and equal reaction. And I think the huge drop that we saw down to 1434 in, in, in March generated its own recovery. Simply based on the fact that the market had dropped that far and had built up such a head of steam downward steam, that it had to react and it did. Whether or not the supply demand balance justified 31 or 30 euros and 80 cents is another question, but it certainly had to react to the huge drop. I find it more interesting and more instructive. As Lewis has previously mentioned, that the market is at or slightly above where it was before we went into the COVID pandemic period, and that we are now trading more or less where we started the year within less than two or 3%. That's more important and more germane to this than anything else I think. Where we go from here, I think we're now in an area that where there's lots more things to consider pandemic related, industrial output related and sentiment related. I think we can we can put brackets around the period between March and July. I. And say, okay we've got done that. Let's just look at the market as a continuum now from the beginning to the end of the year.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 10:45

Lewis, you mentioned hedging. We've seen some of the reports, financial reports coming from utilities, reflecting H one numbers, Q2 numbers. What are you seeing in terms of the hedging numbers and is there any discernible change in trend or is it pretty much business as usual?

Louis Redshaw, founder and CEO Redshaw Advisors: 11:02

There's limited data released so far. We're expecting that some in coming week or so, but there are a couple of companies that have released results, so NL being perhaps the most significant of those, NL being the owner of Spain's ESSA as well. And the reports coming from them indicate they've actually accelerated their hedging program. And that they bought more than they would have ordinarily for the time of year. Now, that is possibly triggered by the the drop that we saw in March. It could be based on, the higher forecast we're expecting next year. We don't know exactly'cause they don't reveal that kind of information. But what it does tell us is that consequence of that is that demand from that company in this case will be lower. As time goes on, because they won't need to buy the stuff they've already bought. We can, if we extended that to all utilities then that becomes significant for the carbon market. But at this stage, it's probably a little bit early to be able to make any kind of prediction about the impact of the impact of this change in small change in hedging strategy.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 12:00

We'll keep our eyes peeled there. Alessandra, you mentioned the green deal and also the potential 2030 targets as a driver going forward. If you have. Increased ambition in an eu recovery in terms of renewables expansion, wouldn't that in turn then reduce demand for uas?

Alessandro Vitelli, Carbon Reporter: 12:21

It would. On, on the surface of it, of course, there's still the fact that people will need backup from some other kind of technology and namely gas in most cases. So there will still be decent some demand. The only problem is how much and when does it kick in? We also have to consider when coal plants are going to be phased out because we're still feeling our way through the schedule going through to 2038. And we heard some noises from Poland in the past couple of weeks, mentioning 2050 or even 2060 as a date when they would leave coal. So we need to factor in the exit dates that are being talked about in various capitals. We also need to factor in, of course, what they do with the surplus of un of no longer needed. EU allowances because that still hasn't been dealt with by many countries. In fact, Germany is the only one as far as I'm aware, that has actually got any kind of plan to deal with unneeded EUAs once coal plants closed down, that also, and I will keep coming back to this, that is a huge sort of re that hangs over this market.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 13:23

Absolutely. If you are coming into a cash strip situation post pandemic or even in the middle of the pandemic, what are you gonna do? Cancel millions worth, millions of euros worth of allowances. You can see the pressures on governments here.

Alessandro Vitelli, Carbon Reporter: 13:35

Yeah. The other problem is, of course, is the European Union itself has actually said, we're going to use revenue from some EUAs to help pay for the rebuilding efforts. And so you do have this, attachment to the revenue from EUAs, which doesn't necessarily fit with the concept of actually canceling EUAs as they're no longer needed by coal plants. We've also got this

Louis Redshaw, founder and CEO Redshaw Advisors: 13:59

increasing talk of price flaws and potentially even price caps, and that's something that you probably wouldn't have heard a lot about while the UK was part of the EU being a. They are. But even the UK and I know we're gonna discuss this shortly, but even the UK is talking about a price floor and in such a situation where lots of people are depending on the cash and companies are calling for certainty, the prospects of a price floor and cap have never been higher. I'm not suggesting that we'll definitely get them, but the increased levels of discussion of the subject. Do suggest that carbon may have a, at least a flaw underneath it in the not too distant future.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 14:39

That's interesting. France has always been one of the countries that's of urged such measures, but that would be quite a departure from the commission, which has always stood back and said, that's not the way we're gonna run the carbon market with caps and floors. Lewis. What's your view here?

Louis Redshaw, founder and CEO Redshaw Advisors: 14:51

Yeah, no, absolutely. But I just think, with the uk outta the eu, the dynamic changes significantly. And the EU has steadfastly stuck to its guns on this message. But I think that if we've had a price spike to 31 Euros in a year, when there's been more supply and less demand, it does suggest that the market's becoming quite sensitive. And if we saw very high prices. We'd have a call for a price cap, so the discussion isn't gonna go away. And indeed it appears to be just getting louder. Exactly. What the European Commission will do is difficult to call and they'll have to respond to the politicians.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 15:27

So there's a risk of a more interventionist commission man. Potentially also based on the noises coming from certain eastern European states who have been quite hard hit by these high carbon prices. But what do you, how do you view the green recovery? What kind of impact can that have on the market, Louis?

Louis Redshaw, founder and CEO Redshaw Advisors: 15:42

So really the green recovery doesn't have an awful lot to do with carbon prices at the moment. So what we are looking at is a target that was established before the virus hit, which was. A 50 to 55% decrease in emissions by 2030. And that's a target increase from 40% that's that we currently have. And what that does is not really affect many people's interaction, many installations interaction with the E-U-E-T-S 'cause they just carry on business as usual. What it does impact is investors interest. The carbon markets in Europe because with that type of target, you're getting a defacto price flaw because what we're saying here is that come what may, the EU ETS is going to be undersupplied and therefore prices can be expected to be material and we're not gonna go back to five euros anytime soon. So that gives more comfort to longer term specula. And indeed companies that are looking to hedge exposure to, for example fossil fuel heavy investment portfolios. The green deal means that we are more likely to get the 55% target which sort of reinforces that potential flaw. The flip side of course, is that emissions drop because there's more investment in greener technologies.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 17:02

Both of you guys are based in the uk and I think I'd like to talk a little bit about that now. Once the UK leaves the eu, what kind of system does it have in place? How does it, a UK trading system, how does it stack up against the EU ETS in terms of ambition and liquidity? Lewis, if I can start with you.

Louis Redshaw, founder and CEO Redshaw Advisors: 17:20

So the UK system is a carbon copy of the EU ETS in large part. There's a couple of tweaks to accommodate few problems they're gonna have trying to link to the. Ultimately the process of measuring emissions, the process of giving out free allocation, benchmarking, the carbon credit itself is, is gonna be a ton of carbon like every other. So the similarities are. Enormous. Prospects for linking to the EU ETS couldn't be higher. And it looks to me, without a very conscious decision that the UK has decided to make their ETS look so much like the EU ets, that it'd be very difficult for the EU to object to a linked system.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 18:02

Alessandra, what are you seeing any sort of innovative elements here that could influence other markets or the commission in terms of looking at, the ETS itself, eu ETS

Alessandro Vitelli, Carbon Reporter: 18:12

Well the talk of a price floor in the government plans for the UK ETS is interesting. It suggests that there is a, an acknowledgement in the UK that they do have to provide some sort of certainty, long-term certainty to the business sector. And it's the same, it's the same discussion that's actually going on in Europe at the moment. So there has been a shift in thinking on how to provide that certainty, and it's happened across Europe and it's being implemented both in Europe. It may be implemented both in Europe and in the uk. There's also a price ceiling, which is, again, something that's been in the European market forever. Anyway. They're also talking about ambition. The UK cap is set at what it, what the UK cap would've been under the E-U-E-T-S minus 5%, which is maybe an acknowledgement that the UK has been slightly over allocated throughout its membership of the E-U-E-T-S. It could also be trying to send a signal. Somehow to the rest of the world that we are still ambitious in the UK and there's still a, an intention to reach the Paris Agreement goals. The other things are more or less, as Lewis said, a carbon copy of the E-U-E-T-S, but there are some tweaks there that kind of say, reflect the slight change in thinking that's going on among policy makers.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 19:25

Are there any compatibility issues here, Lewis? Would the UK have to use the same rules and measures for free allocation as the EU if it wants to pursue the link to the ETS?

Louis Redshaw, founder and CEO Redshaw Advisors: 19:34

Yeah. The temptation, of course, is to give a more generous, free allocation to certain industries, but the intention as we understand it at the moment, is to not do that and to completely. Copy the eus system of free allocation, including the benchmarks, exactly how they would achieve reliable figures for the benchmarks they'd have to rely on the rest of the EU because there simply aren't enough examples of each industry in the UK to be able to do that. So the copying is is almost absolute. And that's intentional, right? It is designed to allow the market to, to link. And the reason you'd want it to link to the EU ETS is to take advantage of the pool of liquidity that the EU ETS represents. EU is a relatively small market and a system would be yet smaller, about one 10th the size. And while I imagine there would be reasonable liquidity in a uk ES, it's gonna be that much better if we. The two together. The price flaw, I think, is designed along with the extra 5% target. So a 45% reduction instead of a 40% reduction by 2030. I think both of those are actually designed to keep the European Commission happy about linking in order to make sure linking happens by the 1st of January. And the reason I think that is because the UK is oversupplied compared to the demand that it has. And by taking away some of that oversupply and committing to not allowing the price to go below a certain level and therefore diluting the EU ETS, I think that's designed to, to increase the chances of linking. And just really briefly on the price ceiling, aand referred Price Ceiling, it's. Additional volume into the market should the price go above a certain level. And they've made those rules slightly more relaxed than the EUS rules. But again, we've done a little bit of basic modeling and the chances of that having a material impact and properly capping price are very slim. Just like in the eus plans. There are some tweaks, but ultimately I don't think they mean a great deal and that linkage is inevitable if the will is there from both parties.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 21:40

It's interesting that the UK has now seen has been coal free for several weeks months even this year. And it may be interesting to see that other European countries follow the example of the carbon price floor as well. It could be interesting to see developments in countries which have that coal fire generation. Gentlemen, thank you very much for joining the Montel Weekly podcast this week. I feel we could we could talk for hours on these issues. A very interesting discussion. Thank you, gentlemen. Thank you. Thank you. That's all for this week. Listeners. We return next week. Keep up to date with all the relevant energy market news on Monte online and subscribe to this podcast on Apple Podcast, Spotify, wherever you get your podcast from. Also remember social media. We are active on LinkedIn and Twitter. Thank you and goodbye.