Carbon dioxide allowance prices under the EU Emissions Trading System surged above Eur23.00/mt ($26.76/mt) Friday, amid bullish moves in the wider energy markets, including stronger natural gas prices.
Intra-day high of Eur23.35/mt, up 8.8% from Thursday's close
Carbon supported by bullish energy markets
EU Allowance futures contracts for December 2018 delivery on the ICE Futures Europe exchange surged as high as Eur23.35/mt, up Eur1.88/mt or 8.8% from Thursday's close of Eur21.47/mt.
That was the highest price for the front-December carbon contract since 2008.
Forward electricity profit margins in continental Europe continue to favor coal, which emits roughly twice the CO2 of natural gas-fired generation, supporting utility hedging.
This has been driven by surging gas prices which are helping to maintain coal's profitability for baseload generation on the forward curve, propping up support for carbon allowances. Gas prices in Europe extended their gains on Friday, adding to carbon's rally.
A London-based carbon trader said a number of factors had combined to propel carbon prices to fresh highs Friday.
"This morning, I see the fuel switch price up about Eur1.75/mt vs settle and dark spreads are up Eur0.60/MWh front cal [calendar 2019] which incentivizes utility hedging," the trader said.
"We also had a very strong auction today with a cover ratio of four," he added, citing bidding interest four times higher than the volume offered in Germany's auction of 4.36 million EUAs Friday.
The auction cleared at Eur22.51/mt -- another all-time high for European carbon auctions.
"Mostly I think it's just momentum and fund money in the market," the trader added.
An energy analyst at a continental utility said EUA options trading may also have been a factor in Friday's sharp gains, alongside strength in energy markets.
"To me, the failure to break below Eur20/mt when prices started to correct downwards earlier this week was the trigger of the present rebound," the analyst said Friday.
"But it came with the help of sustained coal and power prices at the same time. The bullish sentiment was there," she said.
"Now, what drove prices so high and so rapidly this morning is probably call options hedging," the analyst said.
"Although the Open Interest for the September call option on Dec 2018 is small, that of December is relatively strong with 12.5 million mt for a strike of Eur22/mt and 9.2 million mt for a strike of Eur23/mt," she said.
"That is more than 20 million mt coming into the money in just a few hours," she said.
Call options provide the buyer with the right, but not the obligation, to purchase an asset at an agreed strike price.
With those call options for December EUAs moving into the money, this forces options sellers to buy more volume in the futures market to hedge those sales, the analyst said.
Friday's strong auction result and high bidding interest also contributed to gains in the secondary market, she said.
"Seeing that the market is able to increase by Eur2/mt in just one session, even the absolute Phase II highs [above Eur29/mt] could be tested by the end of the year," the analyst said.
Adding to these supportive demand-side drivers, sentiment also remains bullish on the supply side, ahead of expected cuts of about 400 million mt or 40% to carbon auction supply in 2019 due to the Market Stability Reserve.
The MSR will curb the 1.655 billion mt oversupply by 24% per year from 2019 to 2023 and by 12%/year thereafter, rebalancing the carbon market's supply with underlying demand.
Some analysts have said they expect this to drive carbon prices as high as Eur25/mt by the end of the year, and eventually to a level that would prompt coal-to-gas fuel switching among the utilities.
Since rising gas prices are pushing that fuel switching price higher, this continues to drive carbon price gains.
The higher carbon prices also contribute to higher wholesale power prices, boosting the cash flow of low carbon generators operating nuclear, hydro, wind and solar power plants in Europe.
