CO2 prices soar as Germany hints at permit cancellation

Front-year delivery carbon allowances under the EU emissions trading system (ETS) changed hands at more than €28/t of CO2 equivalent (CO2e) for the first time in more than 11 years last week, after the German government indicated that it would be willing to cancel permits as part of its plans to phase out coal-fired power plants.

The EU ETS December 2019 contract ended trading last week at €28.78/t CO2e, having risen by a combined €2.40/t CO2e, or more than 9pc, over the course of the week — the product's largest week-on-week rise since the week beginning 1 April (see chart). This closing value was the highest for any front-year delivery EU ETS product since 1 July 2008.

The vast majority of the week's gains — €2.21/t CO2e — came in the final three trading sessions, after German environment minister Svenja Schulze confirmed on 10 July that her department would back a recommendation to cancel a proportional share of EU ETS allowances to offset the probable reduction in demand for carbon permits that would be caused by the country's closure of coal and lignite-fired units.

The December 2019 contract rose by €1.61/t CO2e on the day of Schulze's announcement — the product's largest day-on-day increase since 27 February — although part of this rise was driven by the absence of any fresh supply entering the market, because of the continuing Brexit-related suspension of auctions of UK-issued allowances.

EU ETS market prices have also historically been particularly susceptible to upward moves during July trading, as market participants expect thinner supplies in August — when allowance auction volumes are halved amid expectations of weaker holiday demand. The carbon market's front-year product has gained month-on-month value during July in all but one of the past six years in anticipation of these reduced supplies.

EU ETS price gains last week also drew support from weather forecasts pointing to the likelihood of another warm spell across large parts of Europe towards the end of July, which could boost the requirement for thermal forms of power generation to meet stronger demand for cooling. Highs of up to 30˚C are expected in Berlin by 20 July, while daytime levels in Paris could exceed 31˚C.

But an increase in thermal power output is unlikely to boost spot demand for carbon allowances as much as it might have done in previous years, with German coal-fired plants remaining firmly behind gas-fired units in the country's expected power sector merit order.

German gas-fired plants are on track to produce more power than coal-fired units for a second consecutive month in July, and for the third month this year, while wind farms remain on track to displace lignite units as the country's largest source of electricity over an entire year for the first time.

Auction demand, traded volumes

Last week's price spike resulted in a significant increase in primary market auction demand and secondary market traded volumes. The three auctions of EU-wide allowances drew bids for an average of roughly 7.4mn permits each, compared with an average of just 5.5mn for all of the sales in 2019 so far.

The auction on 11 July attracted particularly strong demand, with bids submitted for 8.7mn permits, as participants rushed to secure available allowances in the wake of Schulze's announcement before further price rises. This volume bid for was the most for any EU ETS primary market auction this year, and was more than three times the quantity of allowances made available for sale.

Stronger demand for carbon allowances was also reflected in the traded volumes of permits last week. An average of 18.8mn December 2019 delivery permits changed hands at the Intercontinental Exchange during each session last week, compared with a 17.6mn/d average for the whole of the year so far (see chart). More than 30mn front year delivery allowances traded on the exchange on 10 July alone, which was the most for any day since 10 April.

Outlook

A full five-day EU ETS primary market auction schedule returns this week, as a sale of Polish-issued permits will be held on 17 July, while an auction for 892,000 EU-wide aviation allowances is also due to take place that day.

This supply boost could limit the potential for further gains, although the carbon market is likely to find increased support and buying interest towards the end of July as August's supply crunch looms.

EU ETS Dec 19 price change by week €/t CO2e

EU ETS December 2019 contract