EU carbon dioxide allowance prices under the EU Emissions Trading System fell sharply in July in the wake of the UK's vote to leave the EU and as traders began to scale back activity for the summer holiday period.
Rising coal prices also had a negative impact on coal-fired power profit margins, dampening appetite for selling forward power.
EU Allowances for delivery in December 2016 averaged Eur4.65/mt in July, down 98 euro cent or 17% from June's average of Eur5.63/mt, according to S&P Global Platts daily closing assessments.
Carbon prices had already fallen sharply in late June following the June 23 Brexit vote, prompting uncertainty over the UK's future participation in the EU ETS.
Prices fell to a 27-month low of Eur4.44/mt at the close on July 11 before rebounding to Eur4.96/mt on July 15. However, the bearish pressure resumed, sending prices even lower to a 32-month closing low of Eur4.38/mt by August 1, based on the most liquid nearest-December contract.
Carbon trading volumes also showed a sharp fall in late July as traders began to drift away for the holiday period.
"We're seeing less volume trading right now. Traders are closing books before going on holiday," one trader said July 26.
In particular, carbon prices are also coming under pressure from narrowing profits on coal-fired power plants this year, driven by rising coal and relatively low wholesale power prices.
An ongoing recovery in coal prices in 2016 is crushing coal-fired profit margins, with API 2 thermal coal for delivery into Northwest Europe rising from as low as $36.50/mt in February to $61.50/mt by July 29, on a CIF ARA basis for 2017 delivery.
The German year-ahead clean dark spread for 35% efficiency plants -- representing the indicative profit available for coal-fired power including the cost of coal and EUAs -- fell further to a fresh 5.5-year low of Eur0.55/MWh on July 28.
In Q1 2016, the German year-ahead CDS moved in a range of Eur1.74-Eur3.07/MWh, and in 2015 as a whole the range was Eur2.52/MWh to Eur3.96/MWh.
For historical context, in 2012 German year-ahead coal-fired power earned indicative profits of Eur8.28/MWh to Eur11.04/MWh.
For German coal-fired power delivered in Q4, the CDS stood at a more robust range of Eur3.08/MWh to Eur4.34/MWh in July.
A positive CDS supports coal burn, and therefore demand for EUAs, but the narrowing value is dampening the incentive to lock in profit compared with earlier this year and encourages utilities to focus on selling power for the shorter-term rather than the year-ahead and beyond.
There is potential for carbon price upside in August in light of a sharp cut to primary EUA supply from government auctions.
Governments tend to scale back their selling in the quiet summer period, and this is agreed in advance with the European Commission and auction hosts EEX in Germany and the ICE Futures Europe exchange in London.
August was already set to see a drop in auction supply to just 33.67 million mt compared with 69.69 million mt sold in July. This was further reduced to 26.82 million mt as a result of EEX cancelling five EU common auctions in the period August 22 to September 1 due to a gap between the exchange's existing auctioning contract with the EC and the start of its renewed contract starting September 5.
The volume from the five cancelled auctions will be redistributed to the remaining common EU auctions in 2016, EEX said, with details expected to be announced in the first half of August.
