Market and product

EU carbon dioxide allowance prices under the EU Emissions Trading System rallied as high as Eur8.30/mt in Week 51 -- their highest in two years -- as the supply of fresh EUAs from government auctions dried up for the year.

The market's attention has turned to the December 2018 contract following the annual expiry of December 2017-dated futures contracts on December 18.

EU Allowance futures contracts for December 2018 delivery on the ICE Futures Europe exchange were quoted at Eur8.20/mt ($9.72/mt) at midday Friday, up 18 euro cent from Thursday's close, and up 99 euro cent or 13.7% from a week ago.

The last EUA auction of 2017 was held on December 18, halting the supply of primary EUAs entering the market on a spot delivery basis until auctions resume on January 8.

This combined with thinner trading as the market began to wind down ahead of Christmas, increasing price volatility.

"I reckon a great part of that [rally in December] is connected with the tightening of the volumes in auctions," one analyst said.

"The power sector is burning fuels so it's still buying allowances. Electricity demand is on the rise almost everywhere," he said.

But the medium-term outlook was more bearish ahead of the annual free allocation of allowances by EU member state governments -- a process that most of them complete by the end of February.

"Once we approach February I think prices will start to fall again. We've seen it in recent years and this year I think is no different," the analyst said.

"On the mid-term, it'll be interesting to see who is going to hedge forward. Whether it will remain just a utility business or some other industries, steel, ceramics and paper, will get to the market to secure low prices. I think this will happen after the summer," he added.

The rally in the second half of December has more than reversed the losses in the first half of the month, which may have left prices looking more attractive for speculative buyers.

Another analyst agreed the recent rally was linked to a halt to auction supply as well as better prospects of a resolution to the recent Brexit-linked uncertainty over UK-issued allowances.

But other regulatory factors may have also played a part, she said, pointing to upcoming MiFID II regulations that take effect in the New Year.

"In my opinion, market participants cannot be 100% sure that their trading partners get the license, if they are required to get it, by January 3. For this reason, they might bring their purchases forward," she said.

"And I fear that we might see lower prices in January for exactly the same reason. Many market participants won't have the license by then, but the auctions restart January 8. Will there be enough demand to absorb the allowances?" the analyst said.

Under MiFID II, spot and futures/forwards trading in emissions are considered financial instruments, meaning anyone trading in them is potentially covered under the MiFID regulations.

But compliance entities which buy emissions instruments for their own current or future use qualify for an automatic exemption from MiFID.

Analysts estimate that over 90% of EU ETS installations will not have to change anything as a result of MiFID, which generally only applies to the larger trading desks and major utilities.

With the holiday season approaching, resulting in a three day week in Week 52, the expected decline in liquidity is likely to create a thin market next week, which could allow price moves to be more exaggerated than normal, as was the case in week 51.

On December 27, the UK's regulation bringing forward the 2018 compliance deadline to a date well ahead of Brexit day on March 29, 2019, is expected to come into force.

This should allow the European Commission to accept the UK government's ability to enforce 2018 emissions obligations, allowing EUAs issued by UK from January 1 to avoid being tagged with a country ID code in the Union Registry and invalidated for EU ETS compliance.

Given the recent concerns in the market over the Brexit issue and the EU's response to it, such an assurance from the EC may serve to allay any lingering nervousness over UK-issued EUAs.

The UK government is not expected to want to sell assets whose compliance value is in question, risking a failure of auctions in January.

In light of this, the ICE Futures Europe exchange had not published the UK carbon auction calendar for 2018 as of Friday, creating some uncertainty over the first few UK auctions of 2018.

But the UK and EC should be able to agree the calendar dates once clarity emerges over the compliance status of UK EUAs, and this may happen in the final week of 2017 or early in the New Year. - Platts -