Commodity Online
Lower Natural Gas prices, recessionary trends and Coal supply/demand imbalances have led to a situation where European C02 Emissions Trading Scheme (ETS) has more permits than actual emissions, according to an analysis by Bank of America-Merrill Lynch (BofAML).

The phase II of ETS (200-12) will face a similar situation as did phase I (2005-07), however, what is supporting higher prices disconnected from fundamentals now is because it is now bankable into Phase II (2013-20). BofAML estimates put C02 emission from the use of fossil fuels to have fallen by 9.5% last year in Europe, mirroring a decline in industrial activity. It believs emissions for phase II will be 166 mn tones below the cap.

A key objective of the ETS is to force coal-to-natural gas switching in power generation. However, with natural gas prices in Europe falling and coal prices on the rise due to global supply/demand dynamics, gas has already become the fuel of choice. Thus, the theoretical carbon price required to switch from coal into nat gas in this industry is close to zero. Currently trading significantly above the switching level for this summer at €2.80/t, BofAML analysis stated that EUA prices are thus disconnected from short-term fundamental factors.

Buy and sell commodities online

So far, the sole firm piece of information on Phase III carbon prices is that the European Union has committed to a 20% emission cut by 2020 relative to 1990. Full details on both carbon supply and demand dynamics have yet to emerge for the 2013-2020 period. Instead of pricing nearterm energy market conditions, CO2 permits today have the impossible mission of having to signal the required energy efficiency and substitution dynamics over the next 10 years, as well as uncertainty over the supply of permits. Thus, BofAML analysis notes that price direction for CO2 will remain unclear for some time. On the positive side, EMs committed to reduce their CO2 emissions for the first time in Copenhagen.

One bearish signal follows another
The market for EUA continues to be bearish as recessionary trends are not receding faster in Europe. After closing last year at a 25% loss, European allowance units (EUAs) have fallen by 9% since the peak of EUR14.70/mt during the Copenhagen Conference in December. Since then, prices have regained some of their losses but have otherwise struggled to find much direction. Last week’s resilience in pricing seems particularly remarkable in light of the energy complex selling off and temperatures warming up. BofAML analysis said that carbon prices could stay disconnected from energy prices nearterm, while struggling to find much direction in light of the political insecurity. Given the weak fundamentals, no significatn price upside can be expected over the next 3-6 months.
.
Phase II is in surplus
In the short-term, that means the market is structurally long, even before importing CERs or ERUs. BofAML estimates that CO2 emissions from the use of fossil fuels fell by 9.5% last year in Europe, mirroring the decline in industrial activity. According to some estimates, German CO2 emissions fell by 9% to the lowest level since 1990, the biggest yearly fall since 1991. By the
same tune, the US just reported a 6.1% drop last year. Declines in energy consumption in the industrial sectors due to the sharp economic downturn combined with a higher burn of natural gas versus Coal drove the decline in CO2 emissions.

The industrial sector is likely to be a drag on EUA demand
No doubt, the European economy is currently undergoing a recovery and overall industrial indicators and Eurozone IP growth continue to show improvement. However, CO2 emissions are generated by sectors that are overly exposed to the construction sector, like steel, glass and cement, a sector that will likely lag the recovery . True, following a major slide in production, the Steel sector continues to ramp up. Relative to the prior year, the last two months recorded substantial gains. Still, the recovery in production and steel demand in Europe is nowhere near the recovery experienced elsewhere, particularly in Asian markets. While utilization rates will likely continue to trend up in line with underlying demand improvements, a frail construction sector could dampen the recovery in steel and cement output.

Power generation has yet to recover in Europe
The refining sector also exerts a continued drag, with utilization rates at the lowest in many years. According to the latest data, European crude runs are down 7.3% relative to the prior year. Perhaps more importantly, weak power generation remains a major pull on CO2 output as well. While ticking up latelydue to colder-than-normal weather over the past weeks, demand remains considerably below the previous year’s levels across Western Europe.

The lack of political progress is negative near-term
The weak and non-binding Copenhagen Accord introduces uncertainty as to the future demand for carbon offsets. Given the lack of global commitment in Copenhagen, the EU is now unlikely to increase its pledge to cut emissions by 2020 to 30%, as previously discussed, from 20% currently. A move to 30% reductions would have been required to create a much more significant shortfall in the Phase II-III ETS balance. At the same time, the recent shift in power in the US Senate makes federal legislation regarding a future cap-and-trade system increasingly unlikely in 2010, reducing the potential demand for CERs from the United States. All in, the lack of political progress will continue to exert downward pressure on the EU ETS and CDM carbon markets and cap any price rallies.

Copenhagen’s failure: no supra-national carbon framework...
Whichever way one spins it, the Copenhagen conference on climate change was a failure. Rather than agreeing on a structure of a broader global treaty to succeed the 1997 Kyoto Protocol, which binds 40 countries in their greenhouse gas emissions until the end of 2012, the Copenhagen outcome was a wishy- washy accord with vague targets, agreed on by only 29 countries, BofAML analysis said.

Still, Copenhagen does offer a glimpse of hope
In sum, the stars are not yet aligned for a global carbon cap-and-trade system. Still, although details have not yet been agreed upon, developing countries now for the first time made a political commitment to reduce their emissions. So far, China pledged to cut CO2 produced for each unit of economic growth by 40-45% by 2020, relative to 2005. India pledged to cut up to 25% by 2020 from 2005. While these are no major commitments, they are a step in the right direction. US climate legislation will likely happen although a cap-and-trade is not likely to be set up soon. All in, these are bearish signals for European carbon trading and we expect the market to struggle finding much strength near-term.

Post your comment  (0)

Connect:

Post to Twitter

Post to Facebook