Carbon gains continue

Despite calls for calm by the European Commission, carbon prices are continuing to break records, largely due to a soaring gas market and expectations of more stringent environmental legislation.

Listen to a discussion outlining the reasons behind the extreme volatility, the key fundamentals and the outlook for the coming months. 

Guests: 
 • Ingvild Sorhus, Lead EU Carbon Analyst, Refinitiv
 • Bernadett Papp, Analyst, Vertis Environmental Finance

Transcript

0:01

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Richard Sverrisson, Editor-in-Chief Europe, Montel: 0:29

Hello listeners and welcome to the Montel Weekly Podcast, bring You Energy Matters in an informal setting. It's been another, shall we say, eventful week in Europe's carbon market with prices hitting record highs almost on a daily basis. This year, prices have doubled from around 30 euros at the start of the year and have hit all time highs over 40 times over the course of the year. To help us explain the extreme volatility, the key fundamentals and the way forward are two of the carbon market's, most eminent experts. So joining me. Richard Sverrisson is Ingvild Sorhus, analyst at Refinitiv. A warm welcome to you Ingvild.

Ingvild Sorhus, Lead EU Carbon Analyst, Refinitiv: 1:05

Thank you Richard.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 1:06

And hello to you, Bernadett Papp Analyst at Vertis.

Bernadett Papp, Analyst, Vertis Environmental Finance: 1:09

Hi Richard. Thank you very much for an invitation.

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

I hope you're both well and it's very good to have you back. We certainly have a lot to discuss so let me start with you, Ingvild We're seeing prices at the moment. 60 and above what's going on, what's driven prices out of the range of sort of 50 55 we saw earlier in the summer.

Ingvild Sorhus, Lead EU Carbon Analyst, Refinitiv: 1:27

Yeah. Thanks. Thanks Richard. And I think, the main answer is gas. We've seen a gas market that it's like sizzling hot and it's, just going up up. Carbon is really following much of the muse that we see in the European gas market at the moment. And of course, when you're getting close to all time high and that's also fueling when you break records or break levels that you are testing as well. So I think the main element to point to is actually the gas. Currently we see we have record high carbon prices. We are at levels never seen before. But if you look on the impact that carbon has on the power stack, it's really don't have much impact. So it's not triggering. And if fuel switching, we more see the reverse fuel switching because of these extreme levels of of gas.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 2:18

So people are burning more coal rather than gas. This seems quite a sort of perverse thing really.'cause this is, goes against the grain of what the ETS was there to stimulate really, doesn't it?

Ingvild Sorhus, Lead EU Carbon Analyst, Refinitiv: 2:29

Yeah. But it's at the moment it's really not too much carbon. A high carbon price could do. Because it could go up and up, but then it would only kind of chase gas even higher because there is not sufficient gas supply to cater for additional demand in the power sector. So in that sense, it's so much carbon can do at the moment when we have this extreme situation in the fuels market. Gas prices are extremely high, but also for cold prices. We have to also remember that this is more kind of a short term, extreme situation and it's most likely not the more normal situation. Last year we had the complete opposite when we were flooded with gas in Europe and then with low gas prices and much lower coal prices, but now also supported of course by high global demand from Asia. Both for coal and gas, I think we'll see that you will have periods of time where carbon prices won't necessarily trigger immediate emission reductions, but of course that will change also over time, and we need a high carbon price or a carbon price to trigger abatement. Uts in order to reach the overall 2030 targets.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 3:42

Bernadette, do you agree it's all about gas?

Bernadett Papp, Analyst, Vertis Environmental Finance: 3:45

Yes. To be honest, I couldn't agree more it what Ingrid said, and as our company is having compliance entities to purchase allowances and cover. Their emissions. And this is actually the feedback we also receive from our clients that their main concern right now is purchasing power and gas because both prices increased quite a lot for them. On the other hand there is also an interesting trend because. We see these record high carbon prices and maybe fuel switching does not take place at the pace we would expect from appropriately working carbon market. However, an interesting experience I would like to share with you is that more and more industrials are looking already into ways, into new technologies to reduce their emissions already with the current carbon prices. So maybe in the power sector. There are other concerns, gas coal and electricity prices. However, these current carbon prices start to be a motivation for many industrials already.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 4:52

What kind of sectors are they? Bernadett,

Bernadett Papp, Analyst, Vertis Environmental Finance: 4:54

I know about cement companies that already have started investing into new technologies in order to reduce their emissions on the long run.

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

Okay. I'm interesting. I'd just like to say, listeners, if you want to listen to a podcast about the dynamics of what's happening in the gas market we recorded one two weeks ago, but Ingvild, if I can turn to you, we hear from carbon traders that the price movement's all about gas, but when we speak to gas and power traders, they say it's all about carbon. Is there a bit of a chicken and an egg situation going on here?

Ingvild Sorhus, Lead EU Carbon Analyst, Refinitiv: 5:26

Yeah, no, it's I think that's, sometimes it's difficult to pinpoint what's driving what, and we have seen previously that carbon has been a driver for gas. But I think the main direction for carbon has been from gas is not necessarily old days. Sometimes it will be also carbon driving, driving gas prices, but especially in kind of these. Space where we see big correction. You have seen kind of corrections in the gas market that has been quite much larger than in, in the carbon market. So it's from time to time when you don't really have you can point to one specific factor of why. Prices were moving in one day. Of course, it could be also the opposite that carbon moves gas. My impression is that at least from when you had this kind of squeezed gas mark that has been more gas driving carbon than vice versa.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 6:17

You talked about the clients. So I'd like to talk about what's your view going forward in the coming months and into 2022, and what are you advising your clients? Are you want 'em to hold off? Or buy now?

Bernadett Papp, Analyst, Vertis Environmental Finance: 6:28

Yeah. That's the tricky question, I think, or the 1 million question. And just to come back to the carbon market behavior in the last couple of weeks or even months, it might be worth highlighting also the special movements in August. We all know that August is always a little bit special month because we see auction volumes being reduced by 50%. So this means that the primary markets is already less supplied. And in the last five years in four, we have seen prices increasing. So what we have seen this year, the price hitting new maximums is actually not a huge sur surprise to the market participants. I would say on the other hand, it was also interesting to observe. Especially in the last couple of weeks that, for example the open interest in the benchmark contract did not really increase despite the price hitting new records or if we compared the average daily treated volumes in the benchmark contract. We can see that from the average in July, that was around 30 million in August, we have only seen 23 million, which can be an indication for the fact that. Many market participants were still away from the market, maybe running maintenance at their plans, or simply enjoying holidays, and the market was quite thin. And to be honest, in, in these market circumstances, it is very easy to move the market even by couple of euroes. Like we have seen it this year. In one direction or the other, maybe we could we could see those new records also because the market was relatively thin and what's coming up, it's quite difficult to say, but what we can observe right now already is that it's very difficult to find sellers. So I think this is a quite specific market situation because everybody is either waiting for the allowances because. For example, a 2021 free allocation in many cases has not hit the accounts of the clients yet, so they are still waiting for the free allocation. Although having some chitchat with them, we've realized that even after receiving the allowances, not many are considering selling simply because they think that the prices would increase in the future as well. Many of them also expect an obligation to top up so they have to purchase additional allowances because they know that the free location have been reduced. The numbers have been actually published already in the official journal of the eu. So they are just waiting to see the numbers and to see the ewas on their accounts, and would like to start topping up by the end of the year. So therefore, I would say that we might see new records. We cannot exclude the possibility. Verti for example, right now has a yearly maximum expectation of 65 euros. I think that we have to rework our expectations in the upcoming months. But all in all, I think that the expectation is further price increases and a new records, especially if you think about that politicians will also restart negotiations about the fit for 55 package and especially the reforms affecting the current system.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 9:50

So do you think we could go north of 70, Bernadette by the end of the year,

Bernadett Papp, Analyst, Vertis Environmental Finance: 9:54

considering that many companies have this kind of policy, internal policy that they try to cover their emissions, their yearly emissions in the same year. I can easily imagine a a run up a rally by the end of the year. And in this case, we cannot exclude the possibility that the price reaches 70 euros or even higher levels.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 10:16

What's your view here, Ingrid? You highlighted gas earlier and gas broms, announcements here about exports to Europe, seem about exports to Europe, sorry, seems to be key here, both in driving gas prices. Could you see a possibility that if. We see North Stream two flows coming in into Germany end of November, early December. That will cause gas prices to fall and carbon could fall with it. Or do you expect to see prices now in a new range of 60 to 70 even? Even above?

Ingvild Sorhus, Lead EU Carbon Analyst, Refinitiv: 10:48

I think it's too early to say that we are in a new range now because it's so extreme kind of market conditions. And I would say I would be surprised if we see a big correction in the gas market without a correction in carbon market as well. I think the downside risk has got gas reverse, but also looking at the macro sentiment, what happens with COVID if we see a increase in COVID cases. So that could be a XX factor. And then of course the carbon price is kicking in on the electricity prices. And I think there is a worry around Europe about kind of high electricity prices. And even though you can't really blame carbon at the moment, at least not the whole electricity bill can blamed on higher carbon costs. But of course, that's part of the picture as well. So I think this high electricity price may also kind of. Color, the policy discussions that will kick off on the fit for 55 debate. I think it's not necessarily leading to anything on the policy side, but of course, can you do something about gas prices? No. Can politicians do anything about coal prices? No. Can they do something about carbon prices? So it's even though it'll be brought up in discussions, I don't think necessarily, and of course kind of these proposals can be of also price driving, at least in drag, if this proposal, even though it's not a proposal that will necessarily fly, but I think policy making is not made in a vacuum either. That could also color the. Discussions, but EU has agreed on a fit or 55% target for 2030, and you have climate neutrality in 2050. Really depends on the horizon. The policy makers are looking at. When kind of the discussions kicks really off.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 12:37

So you think there could be a danger that the ambition will be lowered in the 54 for 55 package in the negotiations that are coming now over, over the coming months and years?

Ingvild Sorhus, Lead EU Carbon Analyst, Refinitiv: 12:47

No, I don't think the, you have the ambition, right? And if you lower the ambition for the UTS, that means the other sectors will have to take larger burden. But of course there are a lot of elements and lots of factors that don't necessarily change the overall burden for the ets, but will be important for the market to sign. And even though kind of you will now just kick off discussions, I mean they would, these will be lasting for a very long time. But that there will be someone mentioning worries about carbon carbon prices at these levels hitting the electricity. Skills for households, for industry. I think that will come up even though that's not necessarily changing anything in the end. But these kind of that the market sees that there are elements in the proposal that came out from the commission that might be changed with the policy risk. Could also be some input to the carbon market. I also want to mention one thing as well that Ette mentioned kind of the hald auction supply now in August. So now we're starting off with full auction volumes, but the full auction volumes now is lower. Than the fuel auction volumes we had before summer. And that is because now is when you have the COVID effect in the market stability reserve. So the market stability reserve, or how much they will call back from the auctions is based now on. The total number of allocation number that was published after verified emission or in May when we had verified emission support 2020. So because surplus was spilling up because of lower demand in 2020, you're now taking more to MSR or so the auction volumes hitting in the market is, I would say quite much lower than before summer.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 14:31

Can I ask you the same as I asked Bernadette, what's your outlook for the coming months, England? In terms of price, direction,

Bernadett Papp, Analyst, Vertis Environmental Finance: 14:37

we don't see necessarily large downside risk. It will depend very much on the gas market. I think. So we're in the process of updating our price forecast because we're obviously too low, our expectations. So I think it's fair to say that in a fundamental market that is so strong at the moment, it's tricky to say that the market will go substantially down, at least.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 15:00

It's obviously very tricky being an analyst in these kind of conditions and this kind of very. Bullish, in terms of commodity prices and power. It's all very up. Now, Bernadette can, if I can ask you about the risk of market intervention. ING England highlighted some areas which may be, could be looked at. Obviously as she said, politicians can't do anything about the international gas markets or coal markets or the weather, but they can maybe tweak the carbon market. Is this something that you also expect to see more of in the coming months and years?

Bernadett Papp, Analyst, Vertis Environmental Finance: 15:32

To be honest I completely agree with Ingrid about the risk factors. She has just listed also regarding the gas supply and and. Possible changes in the current proposals in the FIT 4 55 package. Although she mentioned one word that I really which is the horizon. And I think this is what we have to keep in mind and before our eyes, because to be honest back in the times when the price was still around six, eight Euros, most of the market participants were a little bit shortsighted. And were thinking from one year to the other because there is a. Once a compliance in a year. However, I think that this will change in the future because everybody sees it very clearly speaking about compliance entities or financial entities also participating actively in this market that the European Commission considers the iets, the emissions trading system as the main tool to decarbonize the European economy and the 2050 target. Is already low on EU level. So we have to reach that target, and I think everybody sees it very clearly that the sooner we act, the costs are lower. Therefore, I do not really expect significant changes to the current proposals because the European Commission drafted those proposals in order to reach, first of all our 2030 target. But then by the end of the day, the 2050 target of the European Union. And what I can see, as I also mentioned, what I can see among our clients is that they also shifted their view, their approach to the carbon market and have a long-term view on it. We can see, of course, a correction in the carbon price. We can see high volatility because of cash prices, because of politicians negotiation, negotiating the reforms. However, I think that the overall trend that shows upwards is given and is a common understanding among the market participants at this moment.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 17:37

There was a lot of talk early in the year about the role of speculators and the funds coming in. Bernadette's now mentioned that actually some compliance, companies are changing their practice their decarbonization. They're really looking closely at this. Have you seen any change in the composition of the active participants in this market over, over the last few months?

Ingvild Sorhus, Lead EU Carbon Analyst, Refinitiv: 17:57

Not necessarily over the last months, I think it's been relatively unchanged, but it's like for instance, investments fund. We see from the commitment of traders, they thought that they're holding a quarter of the length in the market. It's an interesting asset. Still both for those with long-term view and also for those with short-term view for the carbon market. But I think it's fair to say, I mean it's as Bernadett says, industry players are now engaging more in the carbon market than they previously did. When you have very low prices and they receive most of their allowances for free or maybe a surplus of their allowances for free. It didn't matter that much to understand the carbon market, but now that you actually see you have a carbon price at 60, you may be not getting all the allowances that you need for to cover your emissions. And that's really changing the behavior that you now do, the investment and to minimize your carbon emissions going forward. And I think that's. That's one of the thing when you have now a car, high carbon price, you have had high carbon price for for some years now and of course extreme this year, but that's also pushing the investment decision maybe earlier in time than you would have had otherwise. And it's an extreme year now. Yes. It's a high level now. Is it the level where we will see carbon prices the next year? We don't know, but that kind of, this awareness that you have the goal of 2030, you have the goal of 2050, you know where you're going. So if you want to stick as a business in Europe, you need to plan. For the future ahead, and I think a high carbon price is also helping with that. I wanna to just mention one point, and that is also we have to remember that the EU TS is also generating a lot of revenues that can be used now for the greening. That is required in Europe. So the governments are getting now revenues from the daily auctions. We are filling up the modernization fund that will help the eastern European states to transform their, or modernize their electricity sector. We're piling up in the innovation fund with the prices as we have now. And of course it will be costly to take us to be fit for 55 or kind of the green deal. But these money will now be available to help out with this transition that we need to do.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 20:23

Yeah, and I think that's important to mention that, okay, we may see some switching back from gas to coal. There are other positives out there. The companies out there looking very closely at how they can decarbonize as well as the access to these funds, so that's an important point. I'd just like to round off the discussion by asking you to highlight what you think will be the key drivers in the carbon market in the coming weeks and months, to, for the end, from now to the end of the year. Gas is the obvious one, but what would be the others? Ingvild, if I can start with you.

Ingvild Sorhus, Lead EU Carbon Analyst, Refinitiv: 20:51

Yeah, I think weather forecast, I getting closer. When you have a getting weather forecast for winter, will it be a mild winter cold winter? Of course if you have suddenly a lot of wind, if you're filling up the hydro reserves in in, for instance Norway. These are things that will be also of importance. And I think movements in the policy debate I think that could be also, even though it's not necessarily focusing on short term measures, but, or short term effects of a carbon price. But I think, now discussions will pick up and you will see which are the difficult points to agree on, which are the less contested elements. This kind of policy debate could also be input to the carbon price over the autumn. Yeah. And also into next year.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 21:38

And Bernadett, what's your view here? What are the key drivers in, in, in your opinion?

Bernadett Papp, Analyst, Vertis Environmental Finance: 21:42

Politicians returning from their holidays and restarting, negotiate about the reforms of the system could have a high impact. Although nobody really expects a decision within half a year or even one year. But we know this market very well, and we know that. These kind of negotiations can already increase the volatility of the price and more or less define the overall direction of the market. This is one thing. Also, as I've mentioned, our clients are waiting for the distribution of the free allocation. And the third factor that might be worth mentioning is the COVID situation in the European member states. In some countries we see already numbers increasing. Of course, everybody would like to avoid lockdowns and restrictions we have experienced in the last two years. It's very difficult to forecast how the virus situation develops in Europe.

Richard Sverrisson, Editor-in-Chief Europe, Montel: 22:40

I'd like to thank you Ingvild and Bernadett very much for joining the Montel Weekly podcast this week. So listeners, you can now follow the podcast on our own Twitter account, 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. I.