<article><p class="lead">European emissions trading system allowance (EUA) values have resumed their upward charge, soaring to 10-year highs on improved profit margins for coal-fired power generators and higher liquidity, as the market edges closer to the start of its market stability reserve (MSR) mechanism in 2019.</p><p>The EUA market's benchmark December 2018 contract added more than €3/t of CO2 equivalent (CO2e) in the previous three trading sessions to end last week at a 10-year high of €23.22/t CO2e on 7 September. A benchmark EUA contract had not closed above €23/t CO2e since October 2018.</p><p>Prices have since pushed even higher, trading as high as €25.79/t CO2e this morning — roughly 28pc above its closing value on 4 September before its recent run of gains began. A benchmark EUA contract has not closed above this level since July 2008.</p><p>Strong demand in this morning's primary market auction for EUAs drove robust gains in the prevailing secondary market. The auction attracted bids for just over 17mn EUAs, which was more than four times the 4.21mn quantity made available. No EU-wide auction of EUAs has attracted bids for more than this amount since 8 March, when high levels of buying ahead of compliance deadlines for 2017 emissions drove bids for more than 20mn EUAs. </p><p>If the benchmark contract ends today's session above €25.01/t CO2e, it will have recorded the greatest day-on-day gain for any EUA front-year product since December 2011.</p><p>The market has shrugged off expectations that September's higher auction volumes could stall the upward trend this year. Auction supply was halved in August, in anticipation of lower demand during the summer holiday period — this probably contributed to the EUA benchmark contract in August posting its largest month-on-month gain since 2006.</p><p>A total of 82.4mn EUAs are scheduled to be auctioned in September, up from 46.6mn in August. But fresh price drivers have appeared this month, which have seen the market absorb this increase in supply with ease, taking allowance values to new highs.</p><p>A steep rally in German power prices has pulled front-year clean dark spreads to their widest since January, improving the outlook for emissions-intensive thermal generation. The 2019 clean dark spread for a 38pc-efficient coal-fired plant ended Friday at €2.45/MWh, down slightly from 6 September, which was its highest closing level since 3 January.</p><p>In the UK — where gas tends to be ahead of coal in the merit order because of the carbon tax — gas prices climbed last week to a level that could prompt gas-to-coal fuel switching in the coming winter. The first quarter 2019 clean dark spread for a 38pc-efficient coal-fired unit closed Friday at £12.52/MWh. The first quarter clean dark spread has now sat above the clean spark spread for a 55pc-efficient gas-fired plant since 5 September — the first time it had done so this year.</p><p>An uptick in thermal generation has also supported the EUA market's recent upward charge. German coal burn is higher on the year in September so far, signalling increased EUA needs among utilities. Hourly average coal-fired power generation is 10.9GW so far this month, compared with 8.6GW in January-August, and 9.7GW in September 2017.</p><p>EUA market liquidity has increased sharply in September. An average of 21mn EUAs changed hands per session in the month so far, compared with 12.1mn per session in August, data from US-based exchange Ice show.</p><p>Market participants have returned from their holidays and the recent price rises have prompted some utilities to ramp up their hedging to cover future emissions. New speculative investors have also entered the market this month, which can contribute to increased price volatility as these market participants "lean in" to upward or downward trends, traders said.</p><p>"Now more than ever, the [EUA] bull story is circulating among the investment community," a trader said.</p><h2>Exceptional circumstances loom</h2><p>EUA prices have gained during September in each of the past three years, as utilities try to secure any additional credits required for the winter months. But the market faces exceptional circumstances this year, as the start of its MSR draws near. </p><p>The impending start of the mechanism has been the largest driver of the market's price gains throughout 2018. The MSR will absorb excess allowances from the EU ETS at an annual rate of 12pc from January 2019, rising to 24pc from September 2019. </p><p>This impending supply crunch — coupled with the consistent price gains EUAs have posted this year — is probably making some compliance buyers nervous. This could prompt them to buy EUAs earlier than planned, to cover future emissions ahead of any further price gains.</p><p>The MSR will remove excess allowances from auction supply, meaning there are now only three months of auction supply at current normal levels. December volumes are reduced each year owing to reduce demand in the Christmas holiday period.</p><p>And auction supply for the remainder of 2018 is even lower than previously expected. The European Energy Exchange (EEX) <a href="https://direct.argusmedia.com/newsandanalysis/article/1735352">announced last month</a> it will suspend auctions of German-issued EUAs from mid-November until the first quarter of 2019, removing about 22mn allowances from auction supply during these months.</p><p>This may be supporting EUA values during September, by encouraging market participants who had planned to sell excess allowances in the month to wait until December — when auction supply is further reduced and the market will be weeks away from the start of the MSR.But some speculative investors may be tempted to take profits with EUA prices at 10-year highs, releasing more supply into the market this month, market participants said. </p><p>The expiry of September 2018 EUAs on Ice on 19 September could offer another bearish signal to EUAs. A total of 28mn EUAs call options expiring on this date are in the money, according to UK research consultancy Energy Aspects.</p><p>The EUA benchmark contract's price has now more than tripled in the past 12 months, having stood at €6.92/t CO2e on 7 September 2017.</p><p><div class="picture"><div><span class="pic_title">EUA front year contract price</span> <span class="units">€/t CO2e</span></div><img src="https://argus-public-assets-us.s3.amazonaws.com/2018/09/10/euabenchmarkcontract10092018024009.jpg"></div></p><p><div class="picture"><div><span class="pic_title">UK winter 18/19 clean dark, spark spreads</span> <span class="units">£/MWh</span></div><img src="https://argus-public-assets-us.s3.amazonaws.com/2018/09/10/ukwintercleandark,spark10092018024056.jpg"></div></p><p><div class="picture"><div><span class="pic_title">German 4Q18 clean dark, spark spreads</span> <span class="units">€/MWh</span></div><img src="https://argus-public-assets-us.s3.amazonaws.com/2018/09/10/german4q18cleandark,spark10092018030838.jpg"></div></p></article>
