Watching the speculators

Are speculators behind the rise in carbon prices to new heights above EUR 40/t? This week’s podcast delves into the rally, addresses the fundamental factors supporting EUAs and whether placing limits on non-compliance participants is desirable or possible. 

Host: 

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

Guests: 

• Marcus Ferdinand, Head of EU Power and Carbon Analytics, Icis
• Trevor Sikorski, Head of Natural Gas, Oil and Carbon Research, Energy Aspects
• Bernadett Papp, Senior Market Analyst, Vertis
• Alessandro Vitelli, Carbon Reporter

Transcript

Anna Siwecka, freelance journalist/podcaster: 0:01

News drives markets, and every day Montel's experience reporters are on top of the stories that shape European market developments. Can you afford to miss out? Go to monte news.com for the latest price driving stories and a free trial.

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

Hello listeners and welcome to the Montel Weekly podcast. Bring Your Energy Matters in an informal setting. Despite having discussed the carbon market in detail with Ville Soros only two weeks ago, I feel obliged to return to developments in the EU ETS given recent price movements and the discussion around speculators in the market. So listeners, we are very fortunate in having a star gallery of guests in today's show who will be able to explain what's happening to comp prices and why they've risen by over 70% since November. Are these increases and falls of close to 7% sustainable in the medium to long term? So a warm welcome to Trevor Sikorski of Energy Aspects. How are you, Trevor?

Trevor Sikorski, Head of Natural Gas, Oil and Carbon Research, Energy Aspects: 1:10

Very good. Thank you, Richard.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 1:12

And also joining us today is Bernadette Papp of Vertis. Hi Bernadette. How are you?

Bernadett Papp, Senior Market Analyst, Vertis: 1:17

Hi, Richard. I'm fine.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 1:19

Excellent. Great to have you on board. We also have Marcus Ferdinand of Icis, so a big hello to you too.

Marcus Ferdinand, Head of EU Power and Carbon Analytics, Icis: 1:24

Good to be here.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 1:25

Excellent. And and last, but no, by no means least is my old pal, Alessandro Vitelli, who's been covering these markets since the 1880s. Bonjourno, Alessandro and welcome back.

Alessandro Vitelli, Carbon Reporter: 1:34

Thank you. Greetings to you.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 1:35

Let's get started by looking at the recent discussion about spec speculators in the market, hedge funds, pension, and investment funds. Financial boutique players, so they become increasingly active in the ETS, but is the involvement of these speculators so negative? Trevor, if I can start with you?

Trevor Sikorski, Head of Natural Gas, Oil and Carbon Research, Energy Aspects: 1:52

Sure. No, speculation is good. Generally, it increases the efficiency of markets, it creates liquidity. It has all kinds of good things. And if you're looking at it, it almost goes far to say as. It certainly helps with the intertemporal efficiency of the market. And by that without them coming in and without them kind of bidding up prices, you wouldn't see future scarcity being reflected so much in the current period. And you'd say, a lot of the involvement of more speculative capital is coming in for a fundamental reason. That fundamental reason, of course. The expected tightness we're gonna see in this market come, the Green Deal policies and changes to caps and changes to linear reduction factors and changes to all those good things you can add onto that changes to the MSR, but it's just a welter of, I would say bullish things. And, the market just probably wouldn't be reflecting it in much of a way without speculative capital coming in. I think we'll return to a lot of these factors later, but but why is there this concern, Markus, about the role of speculative capital in the market? First,

Marcus Ferdinand, Head of EU Power and Carbon Analytics, Icis: 2:55

I would second what Trevor said. So in a way, speculative physicians or the financial sector as such is quite a, it's a lubricant for the market, right? So it provides the liquidity required for compliance players as well to make the trading efficient. What happens obviously is when there is a too high influence, I would say of speculative positions is that it's a bit, I would say it's frustrating for those who have to make investment decisions based on steady price signals, right? The speculative inflow can create quite a high degree of volatility and having the price moving up by, by 50% over a three months time period, I would say undermines the market integrity as an instrument to provide a reliable pricing for those guys who need to invest in abatement technologies. So that's why it might be seen critical.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 3:38

What's your view here, Bernadette? I'm also interested to find out what's the difference between speculation and hedging and can you really clearly define the two?

Bernadett Papp, Senior Market Analyst, Vertis: 3:46

No, it's actually not not really. Plus possible. Our company where it is, has always served compliance entities. And I have to confess that we are trading both the physical ewas that get delivered to the accounts of the companies, but also the derivatives futures forwards and options. It's very difficult to say. And the even compliance entities are using. These derivative products in order to cover their future emissions because they are trying to fix their margins. So it's not so easy to differentiate between actually compliance purchases and speculation. On the other hand, it's a question that we have received in the last couple of weeks, even months from our clients, what's happening in the market because they have the feeling that the market. Split into two. There are the compliance entities with their usual strategy, purchasing strategy in this market. And we have, let's say, these new players who have been active in the carbon market, actually in my experience since 2008, maybe their presence was not perceived that actively or that definitely since then, just in the last couple of months. But they were active undeniably and I couldn't. Agree more with the previous speakers that they also made a positive contribution to this market because we have liquidity here. The carbon market has been always volatile, so this shouldn't be such a big surprise to the market participants. So I think like everything, this coin also has its two sides.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 5:24

Absolutely. So Alessandro, who. Who is concern? Who, if anybody is concerned by the role of speculators in, in the carbon market?

Alessandro Vitelli, Carbon Reporter: 5:32

I have my doubts that there are people out there who are concerned enough to take steps. All we have seen in the past Fortnite is some unsubstantiated reports that European Commission staff. Representatives, we don't know who they are, have been discussing how to intervene in the market or whether to intervene in the market in a way to restrict. Access or influence of speculators. It's very difficult to nail down this. I spoke with someone from esma, the securities and Markets agency, and I asked them specifically, are you investigating ways to regulate the EUA derivative markets? And they said, we have not received any mandate or any instruction from the European Commission to do I think we have to look deeper into this. Go back to the law, to the regulations, and see what options are available before we start speculating as to who might be thinking about doing it.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 6:28

But is placing limits on, on the role of speculators in the market? Is that a reasonable suggestion Trevor? And how do you go about doing it anyway? It's hard to know if it's reasonable.

Trevor Sikorski, Head of Natural Gas, Oil and Carbon Research, Energy Aspects: 6:38

What I would say is in European energy market position limits aren't on net. So if you look at, a lot of, you can go on ice and you can see all the commodities that have position limits on them. And that includes the TTF contracts. That includes, a lot of the power contracts. So all of those, and and there's even a defined. I would say limit for liquid markets, and I would say the EU ETS doesn't fall into that, but that's, it's about 2,500 lots for the prompt market and 2,500 lots for further dated. And in eus terms, I would ba basically say, you could have, 5 million tons of 5 million tons of open interest. Now if you look at what some of the hedgers are gonna hold, they're gonna help, hold a lot more than that. So if you're, what you're really looking to do is just to kind, cut down on speculative capital. I, I'm not sure how many, how much speculative capital is out there with more than 500 million tons of open interest across the derivative. But certainly you could point to a lot of utilities who are right. And then this is the same problem if you went for physical limits. It's, it would do nothing right if you put them onto the registries.'cause the only people who don't have to go physical eventually are gonna be the specs. Not easy, I would say that they're not unheard of. We see them in other markets, but very hard to design, to get right. So

Richard Sverrisson, Editor-in-Chief Europe, Montel: 7:53

what's your view here, Marcus? Do you think Placing limits is reasonable, is a way of containing this speculative bubble?

Marcus Ferdinand, Head of EU Power and Carbon Analytics, Icis: 8:01

I think first of all, the question is do we really have a problem here at the moment or is that noise right? And I think what other people have said before now as well is, driving the market up to 40 Euro by definition is not what's unintended in a way, right? It's, I think at the moment what happens is that this probably happens. Too to be justified fundamentally, when we look into our modeling, we would still see the markets closing this year at around 35 euro or so. So it's not too off from where we are at the moment, it's a question of the speed of this price increase that I think is concerning people more. Then the actual presence of non-compliance players in this market. I'm not a financial market expert, so I can't really comment on what's feasible here and whatnot. What I do see is that still, I would say the speculative positions compared to the other part of the market, which is compliance layer driven is quite small still. This is still a compliance. Players market in the end. Then I think it's a question of how these strategies evolve over time. On the speculative side, is it like more long-term oriented strategies buy and hold trying to combine some sort of like an environmental agenda with an investment? Or is it quickly in and out? Kind of strategy, which obviously adds much more kind of to the volatility in that regard, right? Which could be seen as a potential danger to this market. So again, I think what we have seen is somehow rumors that someone might have said something about holding limits. We had the same discussion, I think when the MSR was adopted, when the price actually was was going up. Because some market players actually saw it as a, as. Possibility to turn the, their foresight into revenues. And I think the same happens now again, with players actually anticipating that the market is going to be very short. Fundamentally that's a given. It comes at the period of time where we do debate an MSR review and the 2030 target change, which by definition will make this market. Quite a bit shorter. I think this kind of links back to the intertemporal efficiency that that was mentioned earlier as well. There are players who are willing to anticipate these developments quicker than others.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 10:05

Absolutely. Do you think Bernadette, that the problem if it is one is overblown here? That's not really. The reason for these price movements are much more fundamentally driven as both Trevor and Marcus have said.

Bernadett Papp, Senior Market Analyst, Vertis: 10:15

Yeah. What we have seen, I think is an overreaction from actually everybody in market, maybe including us. Yeah. In including journalists, to be honest. No. I just wanted to say to examples to show how difficult it is to differentiate between speculation and hedging. If now rules. Get changed and there is a limitation on the position of the financial entities. Then just imagine a utility coming and wanting to hedge a. Positions one year ahead and just putting in one order of 150 lots. And if we take away the financial entities who provide the liquidity with one bigger order, it can move the market significantly, to upwards. And he's just doing normal hedging. Nothing else, and another thing no names of course, but we have a client who said compliance entity, but saying, okay, the price went up significantly. But once there is a correction in this market, we are ready to hedge or emissions two, three years ahead with prices, let's say three euros below current price levels. So is that a speculation then? Or not, I wouldn't say, but they need the liquidity. They need the volatility to do that. So I think, as I've mentioned, oil coins have the two sides. And the presence of the financial entities has, is its pros and cons. Of course, I personally would not put any limitation on their positions.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 11:45

So Alessandro, apart from spoken to, to esma which you can read on Montel news, but also you've you've looked into Article 29 a, haven't you? Could you tell us a little bit about what this is and if that could be used in this circumstances? Yeah.

Alessandro Vitelli, Carbon Reporter: 11:59

Article 29 A is specifically written to deal with rapid price spikes. It asks or rather it sets a set of criteria that generates what's, what I would call a multiplier if the last six months average price is more than three times the price of either the last two years or the last two full calendar years, depending on your interpretation. That should trigger a meeting of a climate change committee within the European Commission's DG Klima, and they would then discuss what options are available for them to damp down that price spike. Now, back end of 2018, prices had increased by such an extent from, what was it? Seven euros, six euros back in 2017, up towards 25 that the multiplier did reach, according to some calculations, three other calculations said it hadn't quite reached three. So essentially there should have been, or could have been a meeting of that climate change committee within DG Klima. At that time, there wasn't. So that kind of suggests. Another interpretation of Article 29 A, which meant that the multiplier wasn't above three. We're currently now in a situation where the multiplier is just above one or a one point something. We're nowhere near two and nowhere near three by any means yet because we've had high prices now for the past two years. So that avenue, I don't think is open to the Commission for intervention and. It does beg the question, would that address this? I'm not entirely sure. It would you then have to go back to other regulations, MiFID, MiFi, the review of MiFID, which is happening this year, what that might lead ESMA to be asked to do, and you have to ask yourself the question. What is the commission going to regulate? Is it going to regulate physical holdings in the registry or is it going to regulate holdings of futures and derivatives positions because the two are not the same at the same time, also, compliance strategies use both futures and physical eua. So there's also that concern because if the asthma does regulate futures holdings, it might upset some companies strategies for hedging.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 14:10

Trevor, let's get back to the fundamentals here and say, okay, you've gotta, you build a case, you three analysts here build a strong case for a fundamental reason for these high prices. But is there a case to say that. If prices go up much beyond 40, that there is increased political pressure from certain member states that could be exerted upon upon the commission. Or is that just a red herring?

Trevor Sikorski, Head of Natural Gas, Oil and Carbon Research, Energy Aspects: 14:32

No, it's not a red herring. Politicians are sensitive to pricing, eh, but it's hard to know what that price level is. And I think, Marcus was probably referring to that in some ways. This isn't really. Know this price increase isn't at a level that the commission you would feel would be uncomfortable with. We've had lots and lots of policy formation, which is all about getting prices higher. The MSR, backloading, it's been a decade of trying to get carbon prices higher so people will actually do something about it, and invest heavier on the back of the carbon price signal. It feels 40, 45. None of that feels like it's a massive issue for the commission. And I think, we've made the argument here already today, all that's happening is some of that tightness is being brought into the market earlier than what we would've expected given, the fundamentals we see on the ground, let's say today in 2021. And there's a number of things feeding into it, at the moment, which has maybe made it a bit easier to, for reasonably small volumes to drive the market up. The lack of auctions through January means, we haven't had a cumulative amount of heavy supply yet. The lack of reallocation, the factor still in the compliance window for 2020. There's all these kinds of factors that are adding up and I don't think any of them were behind it. It's, it seems a very spec driven kind of event. Particularly when you look at the increases in call options and other ways that the market likes to express a more bullish, viewpoint. So it doesn't, I think at this point you're not really saying there's anything in the market that would allow. The commission as regulator of the market to step in. And I don't think the price levels are really at that level that really is saying, we have a problem that politically has to be solved at this time.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 16:13

Have you revised your forecasts in light of the the price rises we've seen in the last few months?

Trevor Sikorski, Head of Natural Gas, Oil and Carbon Research, Energy Aspects: 16:18

For Q1, yeah.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 16:21

Could you tell us more Trevor for Q1 and for the full year? We'd been saying.

Trevor Sikorski, Head of Natural Gas, Oil and Carbon Research, Energy Aspects: 16:26

And I think we were probably on the, the same page as most of the other analysts. But we'd be, we'd basically been saying we thought that the first half of this year would begin, trading in a 30 to 35 euro ton range. Probably biased towards the bottom half of that. And the second half of this when you started auctions and of course you started auctions and we just had the opposite. We had a movement to a higher range. Now I think it's a little bit, it is very hard to call in terms of where those price ranges go. The longer it stays above. 35 and the longer it's, and if it continues to see technical support around 37 and things like that. The longer you get that, the more comfortable the market gets in a higher trading range, and then the higher, the harder and harder it becomes to move down below because you're resetting the market's expectations from 30 being a good entry point to 35 being a good entry point, and then all of a sudden. You have just moved to a higher equilibrium point, and so we've moved our forecast up to be in that 35 to 40 range probably for now, because we just think, there is some supportive stuff at the moment and when they start to come off, you're into the world of policy formation and the June. Dump of all that information, which is gonna be bullish probably for the market.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 17:41

Marcus, how about your forecast here, not just for Q1 and and, but for the whole year as well?

Marcus Ferdinand, Head of EU Power and Carbon Analytics, Icis: 17:46

I would say fairly stable despite the recent developments. It's, as an analyst especially an analyst that has been in the market for about 10 years now. I've seen quite a few relatively rapid price movements with lots of discussion around them which faded away very quickly as well. It's, again, it's a question whether this is a fundamental change to the underlying. Market situation at the moment, or whether this is a, let's say, according to plan, with regards to demand supply dynamics with a little, let's say hiccup cost by a few commentaries in newspapers, potentially hoping to attract additional waves of money to this market, right? And then trying to push it up. So I would currently, as I said before, I would currently see the market still being dominated by compliance. Related players with obviously an increasing interest from the financial slash investor cement, right? So there is some change happening. This is not the only change. There's also change happening in terms of speed of decarbonization, in terms of how the power sector positions itself against the industry sectors, right? With a much higher rate of decarbonization on the power sector side, the level of fuel switching. Still being there, but decreasing over time.'cause we do have lots of kind of fossil fuel generation being phased out over the period of the next five to 10 years. And where then the question turns more into is this market price that we currently see in the market framework as we see it a good enough policy instrument to also decrease emissions more on the industry side. So these kind of questions obviously on a different level come up when you look into price forecasting. So as said, until 2030, we do see the market being relatively tight. I mean depending obviously on SR review, on 2030 target setting. But general notion is tightness. And then you will always have quite a few kind of events like, like this one at the moment that cause variations to that price trajectory.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 19:40

Perfect. And Bernadette, if I can then ask your view as well on prices for this year and beyond

Bernadett Papp, Senior Market Analyst, Vertis: 19:44

for this year. We have also revised upward a little bit or expectations due to them. Market situation we experienced already in the first months of the year, and also due to expected changes or at least tebo changes by the European Commission referring to the revised 2030 target for this year. We expect the prices to move in the base case and generally elaborate different scenarios for this year. In our base case scenario, we expect the price to move between 32 and 42 euroes. And for the long run. So until 2030, we do not really prepare a long-term model, but at least until the half of the current phase, we see that the price could reach a 50 euro price level easily. And then of course there are more optimistic and more pessimistic scenarios to that.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 20:36

Absolutely. So I was gonna ask you, Alessandra, I mean you speak to analysts and traders in the market regularly. What kind of a spread are we talking for average prices for this year?

Alessandro Vitelli, Carbon Reporter: 20:45

I think where we are today is a little bit beyond some people's expectations. Bear in mind, last summer we were still around the 22 to 25 mark. This is summer 2020, so we have made an awful lot of ground up in just a few short months. And when I held my informal poll of market participants and general observers, the numbers were in the mid upper thirties, so getting about 40 already, I think, exceeds most people's expectations. I think the other thing and the things that's important to point out is that the EU itself, the commission rather, should not be overly surprised at where prices are. They themselves published their hydrogen strategy last summer. In which they said they expect the carbon price to have to be 90 euros by 2030 in order to have green hydrogen competing. So they kind, they've set the target themselves with that. And I think that any, any market movement that moves to fulfill their expectations, policy expectations I should add, shouldn't be a surprise.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 21:50

If I can ask you guys to wrap up today's pod, a very interesting discussion, both in terms of what's happening on the speculative side and also fundamentally, but I think, we've got the discussion around speculation. We've got the 2030 targets coming up, the review of the UETS. What would be your, on your wishlist to the commission? Trevor?

Trevor Sikorski, Head of Natural Gas, Oil and Carbon Research, Energy Aspects: 22:10

I really don't have any,

Richard Sverrisson, Editor-in-Chief Europe, Montel: 22:12

no. Just let them proceed as they're doing at the moment.

Trevor Sikorski, Head of Natural Gas, Oil and Carbon Research, Energy Aspects: 22:15

I think my wishlist would be generally for light touch regulation. I don't think this market needs heavy headed regulation. I think when we look at things like the MSR review, we don't really know what this market will function like when you start getting down to, to even less than a gigatons of surplus, right? So why are you gonna be. Be playing around in adjusting a whole bunch of parameters in something. We really don't, when we really don't know what this market's gonna behave like. When you get down there and if you're saying, we're worried about a little bit of speculative capital coming in when we still have 1.6 gigatons of surplus, then I think, you've got really say. Or you can't be moving, you shouldn't be moving those MSR parameters around a lot because that, if anything, is gonna make this market really tight and take a lot of flexi, inherent flexibility in this market outta it. So my wishlist would just be, very light touch regulation on those kinds of things.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 23:11

Thanks. And you, Marcus.

Marcus Ferdinand, Head of EU Power and Carbon Analytics, Icis: 23:12

Being an independent analyst in this market, I generally do not have wishlists for political de decision makers usually. I just look at what's on the plate and and then analyze it. We have just released a report actually on the interplay between the MSR review and the 2030 target discussion, and it basically shows that, both like. There's obviously more policy processes and legislative processes outplaying at the moment, but especially those two are quite important for how the market positions itself or how it acts over the next 10 years. So those reforms certainly have to be looked at, in tandem because the interplay is quite significant to the market balance and to prices. We have looked into what a ING potentially could to. Basically came to the conclusion that obviously the earlier the 2030 target trajectory is put in place, the less importance there is on the MSR. So you basically reduce the. The significance of the MSR as a price driver, which I think in a way is an intended kind of political decision when you sharpen the 2030 target. So I would say this is at least the direction that I would think the market would favor. So bit along the lines of what Trevor, as well said, don't be micromanaging it. But make sure that until the kind of increase 2030 target ambition is in place. Then the MSR is there as a tool to basically protect the market from shocks.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 24:34

And Bernadette, can I ask you as well what's what would you like to see on the policy front?

Bernadett Papp, Senior Market Analyst, Vertis: 24:39

My only wish timely action, and I think all the compliance entities would agree with me. So for me, as analysts. The sooner we have the decisions. Less negotiation, negotiating time between council, parliament and commission. The better our models or more accurate our models can be. And also for the compliance entities we are serving. It's easier to prepare for the upcoming challenges.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 25:04

Last but least again, Alessandro, you are, you're the last in line. What do you think? What's on your, what's on your wishlist?

Alessandro Vitelli, Carbon Reporter: 25:09

No. I wish I will be able to report on these developments as they happen. I wish I'll be able to understand them. And that's about as far as I'm prepared to go as a

Richard Sverrisson, Editor-in-Chief Europe, Montel: 25:18

journalist. I don't think I can have a view and explain them to the market, of course, as well. I hope so. I hope so. Yeah. Thank you all of you very much for joining the Monte Weekly podcast this week. I think we had a fascinating discussion and highlighted certainly all the main points that are relevant at the moment and will be for the foreseeable future. So thanks everyone. So listeners, you can now follow the podcast on our own Twitter accounts, aply named the Montel Weekly podcast. Please direct message. Any suggestions, questions, or let us know if you think you have a good idea for a guest on the show, you can also send us an email to podcast@montenews.com. Lastly, remember to keep up to date with all that's happening in energy markets on Montel News. You can subscribe on Apple Podcasts and Spotify or wherever you get your podcasts from. Thank you and goodbye.