EU carbon dioxide allowance prices could push higher to an estimated coal-to-gas fuel switching price of Eur35/mt before the second quarter of 2020, according to research released Wednesday by Societe Generale.
The potential for further upside comes as carbon prices close in on the Eur30.00/mt ($33.44/mt) mark for the first time since 2006.
EU Allowance futures contracts for December 2019 delivery on the ICE Futures Europe exchange hit a 13-year intraday high of Eur29.95/mt Wednesday, before easing to Eur29.10/mt by the afternoon.
"The mid-July rally which saw CO2 trade up to Eur29.45/mt was driven by the brief spike in [natural] gas prices and hence the fuel switch," said SocGen managing director and energy analyst Lueder Schumacher.
"The rally since last Friday is likely to be driven by the current heat wave and memories of what this did to gas and CO2 prices last year," he said in a note to clients.
Carbon and gas prices rallied sharply in August and September 2018, although both fell back in subsequent weeks. The spike was linked to an extended heat wave that year that caused a significant demand boost that benefited gas significantly more than coal, pushing up the fuel switching price for carbon.
Recent increases have been linked to a repeat of last year's heat wave conditions across much of Europe in Week 30, as well as a looming sharp cut to primary EUA supplies in August.
"With such strong momentum building ahead of August, when auction volumes are halved, it could well continue," said Schumacher.
In the last 11 years, CO2 prices rose every August - when governments cut the volume sold in the peak holiday season - giving an average return of 9.2%, he said. But the longer-term outlook also suggests the potential for price gains linked to underlying hedging demand from utilities, he said.
"We expected CO2 to trade up to the fuel switch on average efficiencies, currently at Eur35/mt, by Q2 2020. It could well get there earlier," Schumacher said.
"We believe that more than 30-40 million mt of [CO2] abatement from fuel switching will be required to balance the market for 2019," he said. "As a result, we expect EUAs to trade up to the fuel switch on average efficiencies the closer we get to the April 30, 2020 deadline to surrender allowances for emissions in 2019."
"That is when the impact of the [Market Stability Reserve] should become most visible and we should find out just how much of the likely deficit between supply and demand was already hedged," he said. "We currently see this fuel switch at Eur35/mt."
S&P Global Platts Analytics' most recent forecast has a less bullish outlook, showing carbon prices at Eur27.00/mt by December 2019 and rising to Eur30.20/mt by December 2020, according to its monthly EU ETS Market Outlook, which was released July 14.
Platts Analytics sees a potential for lower gas prices throughout the upcoming winter on healthy LNG supplies that will limit storage withdrawals. Other things being equal, lower gas prices this winter, if borne out, would be expected to reduce the implied coal-to-gas fuel switching level, weighing on carbon prices.
