Certain carbon uncertainty

Reform of the mechanism to reduce market oversupply, tweaking the cap and not least the final 2030 target are all uncertain factors for the EU ETS which will continue to cause price volatility in the coming months. Listen to a discussion on current EUA price dynamics and where the market is heading in the short as well as medium term. 

Host: 

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

Guest: 

• Ingvild Sorhus, Senior Analyst, Refinitiv. 

Transcript

Anna Siwecka, freelance journalist/podcaster: 0:01

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Richard Sverrisson, Editor-in-Chief Europe, Montel: 0:34

Hello listeners and welcome to the Montel Weekly podcast, bring Your Energy Matters in an informal setting. In today's pod, we look at what's currently driving European carbon prices. This month prices have ranged between 22 euros and 28 euros. Joining me, Richard Sverrisson, to discuss carbon market dynamics is Ingvild Sorhus, who's a carbon market expert at Refinitiv. A warm welcome to you, Ingvild.

Ingvild Sorhus, Senior Analyst, Refinitiv: 1:02

Thank you, Richard, and it's really nice being here.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 1:04

You're always welcome on the podcast Ingvild, let's start today by discussing current market dynamics. So we've seen, since we last spoke, I think the only thing that's quite certain here is these prices are very volatile. This market has moved quite a lot. What are the main drivers at the moment?

Ingvild Sorhus, Senior Analyst, Refinitiv: 1:20

Good question. It's a lot of different drivers. Of course, we have seen carbon moving alongside the positive vaccine use, reacting to that as well, especially the when the first like results from the third pace test of the Pfizer vaccine and the then Moderna vaccine test results came in that moved carbon alongside all the other markets. So it's also taken cues from equity market as it has been since. March when you first had carbon plunging and then recovering together with equities. But on top of that, it's also this week on Tuesday, we had the announcement from the European Commission that the auction start will be, or the auction start in 2020 will be delayed. Normally it starts in the beginning of January, next year. They said due to technical reasons, it will be delayed until end of January, beginning of February. So a prolongation of no supply from auctions. The auctions will stop in the middle of mid of December as they normally do, and then they won't resume until the end of January at the earliest. And also they announced the cap for phase four. The commission have recalculated the cap removing UK from the UTS cap and also calculating'cause the cap will be reduced at a faster pace from 2021 and onwards that have been known for a while and they gave this number now on Tuesday. So especially, I think we saw a bullish reaction then on, on Wednesday because of this, especially this auction, delayed news. I think now on Thursday, the market is a bit bearish. Again. You have this discussion on the 2030 emission reduction target for Europe, and that was a supportive factor for carbon. Clearly in, in August and September when the commission proposed this 55%, 2030 target for a greenhouse gas emissions in Europe, and then also the European Parliament supported the 60% emission reduction target. For 2030. Now we're waiting for the member states to agree and it's set to be a council in our EU counts or EU summit, 10th of and 11th of December. And now it seems that it might should be that the 2030 target is pushed out the agenda because there are so many things piling up. What kind of the budget and Brexit and other things. So it's remains to be seen if it will be on the agenda for 2030. So I think that was put forward in the news on Wednesday and Thursday. We see kind of market reacting a bit to that probably today

Richard Sverrisson, Editor-in-Chief Europe, Montel: 4:01

in terms of the budget issues and Poland and Hungary through a spanner in the works here. And do you think that may push, if I understand you correctly, will, you are saying then that could push. The 2030 discussion of the agenda or maybe delay it, and is the market feeling, is it quite jittery about that then?

Ingvild Sorhus, Senior Analyst, Refinitiv: 4:19

I'm not really sure what the market has priced in. It's a bit difficult to assess. Even if you have the climate target on the agenda for 10th and 11th of December, it's not certain that you will get the result or kind of an agreement on the 23rd target. It's especially some of the Eastern European countries has raised their concerns about raising the 2030 emission target to 55% saying that. The left details on how this will impact their regions, their industries. I think it's tough negotiations going on. It's Germany who holds the presidency at the moment, and they have stated in their presidency that they want to deliver on the 2030 target before their presidency ends at the end of the year. I think it's not certain that we will have a 2030 target, even if it's on the agenda for the 10th and 11th of December. It depends on how much the Poland and Hungary and other Eastern Europeans states are demanding. And if the other countries are willing to. To give in on that.

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

So weeks and weeks of horse trading probably here, but and again, the only thing that's certain is that it's gonna be very uncertain. Yes. How about the outlook for next year, Ville? Okay, we're talking about the coming weeks and in December, but if we look at the whole 2021, the start of phase four. What's gonna support or pressurize prices?

Ingvild Sorhus, Senior Analyst, Refinitiv: 5:47

I think for the first thing, in the beginning of the year and probably a factor for the rest of the year as well, is, as you say, the phase four. So the next trading phase for the UTS is starting in 2021. The EUTS companies that needs to report on their emissions. They're reporting the 2020 emissions in end of March, and then they need to hand in allowances at the end of April. Between phase three and phase four, you can't use phase four allowances, so anything that is issued in 2021. So that means all the uas coming on options next year, all the free allocations, it might not be necessarily handed out for free before compliance deadline, but. Those allowances cannot be used. So you need to use EUAs that was issued or have been issued in phase three for your 2020 compliance. So I think this uncertainty and also this maybe the psychology in the market that you believe that someone is. Are not aware of this rule yet, might be a supportive factor for the end of the year and also the beginning or for first quarter of next year. So this phase three, phase four transition risk for could be then a supportive factor for the beginning of the year at least. And then it's an also an important year when it comes to policy. So even though we have a 2030 target in place. It's so many details that needs to be settled for the EUTS directive and it's so many parameters that will be adjusted and could have a big market impact. And in next summer the commission will put forward the proposal for a new EUTS legislation, so the changes that will be needed to meet a new emission reduction target. And I think there will be a lot of, continue to be, a lot of focus on the policy. So even if the 2030 target is set, it's still a lot of parameters and factors that will be very important for the market dynamics up till 2030.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 7:52

Could you highlight some of those parameters for us? Maybe the top three, if you like.

Ingvild Sorhus, Senior Analyst, Refinitiv: 7:56

Yeah. So I will say the how the linear reduction factors. So that's. The factor that says how much the cap is reduced per year. So of course that needs to be adjusted in order to meet the 2030 targets. And then it's kind of discussion about this rebasing of the cap. Because now the cap is quite high compared to actual emissions. And we had a review of the EETS directive prior to phase four, which was concluded in 2018. And then there were kind of people voicing that you should really base the cap. So the. That the supply should be more aligned to the demand side and that ID was circulated by the commission in the impact assessment that was accompany when they proposed to have a 55% emission reduction target for 2030. So that will be interesting to watch. And I think also the market stability reserve discussion will be very important. That was the savior for the EUTS. The EUTS has been struggling quite a long time on for many years with this oversupply. And you had this policy interventions first you had the back loading, holding back allowances to try to rise to price again. And then you got this more structural reform, this market stability reserve that kicked off in 2019 where you hold back allowances from the market. From auctions when it's an oversupply in the market. So this was probably one of the most important factors of why we saw the price rise in 2018 and why we see prices at the levels we are seeing today because they're better reba balancing the market and that it will tighten the market once you have oversupply in the market. And we in Refinitiv, we see that when we do modeling for kind of emission trajectory up till 2030 and implementing the policy changes that are proposed by the commission. We see that the power sector is rapidly greening, so we see emissions are dropping quite fast, and we also see a need for A MSR to be working, even though kind of you get the tighter system, it will be an important instrument. And of course now it's working, removing 24% of the oversupply each year. It's set to go back to 12% intake rate to from 2024 and onwards. This is one of the things that they will discuss at the intake rate, the thresholds of when the marketability reserve should be active and not. So really assessing the functionality of the marketability reserve. And of course, it was scheduled to be a review of the market the MSR, regardless of a new target. But of course now it will be looked in parallel with the overall revision of the system. These three things are probably, at least for the supply and demand balance up to 2030, I think they, these three things will be key to watch.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 10:56

Absolutely. And that's a very good summary there. But this MSR reform, is that really just changing the cap by the back door in a sense?

Ingvild Sorhus, Senior Analyst, Refinitiv: 11:04

Yeah. Yeah. Okay. I would say that.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 11:06

Okay.

Ingvild Sorhus, Senior Analyst, Refinitiv: 11:06

It was supposed to be a tool for better balancing the market. We see the importance of the marketability reserve. Now, and prices have been quite high compared to, for instance, the fundamentally picture has been quite bearish this year with COVID and we expect emissions to drop quite heavily this year due to less demand for the COVID destruction. But it's still holding up and I think you know that the MSR will work on this additional surface in the market. So in that sense, yes, it's, you didn't do the rebasing before or when you did the review of phase four, but I would say that MSR is working as. Kind of year on year rebasing of the cap. So of course if you decide on the rebasing, you need to also look at the MSR because you can't do a rebasing and have MSR on top of that because MSR is working with the legs. So of course then you need to look at the whole package together and see the consequence of the rebasing and how them. The MSR should work on top of that.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 12:08

You said you expect emissions to post a fall for 2020. When they come to the reporting at the end of March next year, do you have a number for a single? Is it 5%? Is it 10%, or less, much less than that.

Ingvild Sorhus, Senior Analyst, Refinitiv: 12:19

We expect emissions to drop from 29 19 levels. 16%.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 12:23

16%. Wow.

Ingvild Sorhus, Senior Analyst, Refinitiv: 12:24

16%. Of course, we've seen a big drop in emissions from the power sector, but also then from the industry sector. We've seen. Much lower demand and less coal running. For Germany it's 30% less coal running in, in 2030. And of course a combination between lower demand and also cheap gas and lots of renewables. So of course, we saw a massive drop in 2019 was around 9% from 2018 to 2019. Most due to fuel switching, taking place, less coal running compared to gas. And then from 2019 and 2020, we see a 16% drop on top of that. So

Richard Sverrisson, Editor-in-Chief Europe, Montel: 12:58

that's substantial. We've seen, prices touch 30 on a couple of occasions this year. England, what's your expectation for next year? Are we gonna return to 30 and move above it, or?

Ingvild Sorhus, Senior Analyst, Refinitiv: 13:10

It's a very good question. It's as you say, it's quite volatile volatile market. For Q1, we have a price forecast of 29. We still stuck with the old framework and it depends a bit how soon the market is pricing in kind of tightening of the framework for the years to come. Of course, policymaking processes takes a lot of time in eu, of course, the. First thing is that commission will come forward with the proposal next year. It will take time. And then the European Parliament and the European member states start to work on this in parallel coming up with their amendments to the proposal and changes how they want to see the directive. B. And then when you have parliament agreeing on their position and the member states agreeing on their positions, they will meet and then they will try to negotiate a common position. And then you, of course, when they have agreed you need to have some leeway in order to implement all these changes as well. So of course it will take time before legislation will be changed in order to reflect on new targets. So we have a bit careful trajectory in the beginning or kind of over the next few years before it really starts to go up towards the mid phase. And then towards the end of the year we have quite a big steep trajectory for our price forecast. So we expect prices to range around 28 for next year, and then up to 32 in 2024. And then from 2025, it's. Up from 35 and then in 2030 we will go to 89 euros.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 14:46

Interesting. Ingrid you talked a little bit earlier about the power sector and how they were, becoming much more or decarbonizing quite rapidly. We've seen in the, in, in the third quarter, a lot of these companies reported hedging numbers. Is there anything that sort of jumped out at you from these numbers?

Ingvild Sorhus, Senior Analyst, Refinitiv: 15:01

It's it seems to be that they're quite active. Our impression is that they are keeping. Still active in hedging and are following more kind of the same pattern as they normally do. So even though we have quite a lot of lower emissions and probably, depends on the recovery of the economy of course, but also next year that we will, we might see lower emissions due to lower economic activity compared to a normal year. But it seems like utilities are hedging as normal is our impression at least.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 15:33

What's the sort of medium term view here? Because as they decarbonize and burn less coal, burn less gas, then the demand for ES EUAs will fall. And how will that impact the market? You're seeing if the big carbon emitters are suddenly producing renewable energy, then a massive amount of demand for UAS will, yeah. Will be leave the market, but

Ingvild Sorhus, Senior Analyst, Refinitiv: 15:55

yeah, and that's also why we see prices are not. Skyrocketing already now because we see that emissions in the power sector are decreasing quite rapidly. Of course, the cap also is tightening and the MSR is working on top of that as well. But of course, and that's also why we see the MSR going to be an important tool going forward as well, even though you've tightened the cap even more to get to a 55% target. Is exactly because you have the rapid greening of the power sector and then of course less demand for eua. So in that sense, where, the short term or the short term emission reduction potential is coming from the power sector. You switch from coal to gas or switch to more efficient power plants with less emissions. But of course when you do coal phase out, you do more inclusion of or facing of renewables. Then towards the end of the. Phase four. So towards end of 2030, you will see the emission reduction potential being more or less exhausted in the power sector. You don't have this call to switch possibility anymore because the fossil fuel that is running needs to run. So then you need to call on industry to do more costly abatement options. So that's why we see towards the end of the phase that it's really, you need to have prices to incentivize industry sectors to do the abatement that is needed in the market. Just

Richard Sverrisson, Editor-in-Chief Europe, Montel: 17:24

to round up now, Ville, if we come back to, I think you mentioned it a little bit earlier, but the B word Brexit. And so 1st of January the UK leaves the eu. What are the current plans for the UK and an ETS? Is it gonna be its own ETS? Is it gonna link to the EU ETS or what? What's happening here and how will that impact the market?

Ingvild Sorhus, Senior Analyst, Refinitiv: 17:45

Yeah, good question. And I think the UK installations are wondering about the same. I think you have mixed signals someone saying mean the base is working on the UK standalone ETS, and of course they voiced also the possibility to link back to the EUTS. But there has been also kind of treasury saying that they rather will have a tax. So I think it's not really clear how it'll develop. We think maybe it will be a UK ETS standalone in the beginning. And then of course, UK has always been an advocate for ETS and is probably why we see the EUTS as it is today. If it hadn't been for uk, we wouldn't probably have had kind of the same ETS as we have today. So of course, maybe longer down the lane, we'll see a link linkage between the UK ETS and the UTS. But, history shows, it takes a bit of time before you get the linkage. So I think we need more clarity, both on the UK climate policy and the EU climate policy, which is more in the making. Before you can start talking also about linking.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 18:50

Absolutely, and in post COVID world, and there are lots of other things that maybe are above on the list of priorities here. So Il, thank you very much for providing some clarity in this very complex market and explaining what the current dynamics are. So always a pleasure to have you on the podcast IL thank you again.

Ingvild Sorhus, Senior Analyst, Refinitiv: 19:08

Always nice to talk to you, Richard. Thanks.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 19:12

So listeners, that's about all from the Montel Weekly podcast this week. You can follow the podcast on our own Twitter accounts, and please direct any suggestions, questions, or ideas for potential guests by email to podcast@montenews.com or by direct message. Lastly, remember to keep up to date with all that's happening in energy markets across Europe on Montel News. You can subscribe wherever you get your podcast from and please leave a review and rate us if you can. That helps us to improve. Thank you and goodbye.