Brexit delay to 'boost EU ETS fundamentals'

A delay to the UK's exit from the EU would support EU emissions trading system (ETS) allowance market fundamentals, market participants said.

The UK is scheduled to exit the EU in eight days, on 29 March. UK prime minister Theresa May yesterday requested to delay the country's departure to 30 June.

The EU will agree to a "short extension" to the UK's EU exit date, but only if UK MPs approve the UK and EU's Brexit withdrawal agreement beforehand, effectively confirming that the country would exit the EU with a deal in place, European Council president Donald Tusk said yesterday.

A delay to the UK's EU exit — either a short-term extension of a few months, or a longer two-year delay — would appear to confirm that the UK would remain in the EU ETS until the end of 2020. This would be the default situation if the UK exits the EU with an agreed deal.

This would remove the possibility that the UK would exit the carbon market on 29 March, the default outcome if there is a "no deal" Brexit.

A no deal EU exit is widely perceived as a potentially bearish event for the EU ETS allowance market, as it could prompt UK emitters to sell off spare allowances they would no longer need for compliance. German utility Uniper said last week that it may opt to do this under a no-deal Brexit.

But by ruling this out, a delayed Brexit could kick-start allowance demand among UK emitters, boost market sentiment by removing the threat of a disruptive UK exit from the EU ETS, and tempt speculative investors to take out new long positions in EU ETS allowances.

Until a Brexit outcome is confirmed, UK installations will not know if they will be required to buy EU ETS allowances to cover their 2019 emissions. A short extension, if it ruled out a no-deal scenario, would confirm that UK emitters will remain in the carbon market until the end of 2020.

This could cause a bullish shift in market fundamentals, as any increase in UK demand would not be met with a simultaneous increase in supply. The EU has suspended auctions of UK-issued allowances since 1 January, and such sales will only resume after the UK and EU have both ratified a Brexit deal — a process that could take months.

"This will cause UK installations to know they should be buying again, but UK supply remains switched off," UK-based carbon consultancy Redshaw Advisors founder Louis Redshaw said.

"When there is any sign of delaying [Brexit], or a reduced probability of a hard Brexit, allowances get stronger," a trader said.

Allowances prices ended a three-session run of losses yesterday, following the news that May had requested to delay the UK's EU exit date.

The EU ETS market also rallied on 14 March, after UK MPs voted to rule out a no-deal EU exit.

Long-term delay

The UK also has the option of delaying Brexit for two years by revoking Article 50, and then invoking the article again, which would restart the two-year deadline until its EU exit.

Article 50 of the treaty on the EU sets out the procedure for a member state's voluntary departure from the EU. The European Court of Justice ruled in December that the UK is free to unilaterally revoke Article 50.

This would see the UK remain part of the EU ETS until the end of 2020 — confirming "business as usual" in the carbon market until the end of the market's current trading phase (2013-20).

A two-year delay to Brexit "would effectively remove the risk of a disruptive no-deal Brexit from the December 2019 and December 2020 [allowance] contracts. The market would be likely to see a jump on the announcement of a lengthy extension," consultancy Energy Aspects said in a research note this week.

Beyond Brexit

The UK's relationship with the EU ETS beyond 2020 remains unclear.

Following Brexit, the UK government has said it intends to launch a domestic ETS in 2021 that is linked to the EU scheme.

But the government is also considering launching a stand-alone UK ETS as a fall-back option, if a linked scheme is not possible. This would significantly reduce the volume of emissions covered by the EU ETS — the UK accounted for roughly 8pc of all EU ETS emissions in 2017.