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A ”Game of Chicken”: How long do you dare to wait before buying?

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The EUA market rallied 3.4% ydy and is adding another 0.5% this afternoon with EUA Dec-24 at EUR 54.2/ton. Despite the current bounce in prices we think that the ongoing sell-off in EUA prices still has another EUR 10/ton downside from here which will place the low-point of EUA Dec-24 and Dec-25 at around around EUR 45/ton. Rapidly rising natural gas inventory surplus versus normal and nat gas demand in Europe at 23% below normal will likely continue to depress nat gas prices in Europe and along with that EUA prices. The EUA price will likely struggle to break below the EUR 50/ton level, but we think it will break.

Bjarne Schieldrop, Chief analyst commodities at SEB
Bjarne Schieldrop, Chief analyst commodities, SEB

That said, our strong view is still that the deal of the year is to build strategic long positions in EUA contracts. These certificates are ”licence to operate” for all companies who are participants in the EU ETS irrespective whether it is industry, shipping, aviation or utilities. We have argued this strongly towards our corporate clients. The feedback we are getting is that many of them indeed are planning to do just that with board approvals pending. Issuance of EUAs is set to fall sharply from 2026 onward. The Market Stability Reserve (MSR) mechanism will clean out any surplus EUAs above 833 m t by 2025/26. Medium-term market outlook 2026/27 is unchanged and not impacted by current bearish market fundamentals with fair EUA price north of EUR 100/ton by then. Building strategic long position in EUAs in 2024 is not about pinpointing the low point which we think will be around EUR 45/ton, but instead all about implementing a solid strategic purchasing plan for EUAs for 2024.

The ingredients in the bottoming process will be: 1) Re-start of European industry as energy prices come down to normal, 2) Revival in nat gas demand as this happens, 3) Nat gas prices finding a floor and possibly rebounding a bit as this happens, 4) Asian nat gas demand reviving as nat gas now normally priced versus oil, 5) Strategic purchasing of EUA by market participants in the EU ETS, 6) Speculative buying of EUAs, 7) Bullish political intervention in H2-24 and 2025 as EU economies revive on cheap energy and politicians have 2024-elections behind them.

On #1 we now see calculations that aluminium smelters in Europe now are in-the-money but not restarted yet. On #2 we see that demand destruction (temp. adj.) in Europe is starting to fade a bit. On #3 we have not seen that yet. On #4 we see stronger flows of LNG to Asia. On #5 we see lots of our corporate clients planning to purchase strategically and finding current EUA prices attractive.  On #6 it may be a bit early and so as well for #7.  

For EU ETS participants it may be a ”Game of Chicken”: How long do you dare to wait before buying? Those who wait too long may find the carbon constrained future hard to handle. 

Ydy’s short-covering rally lost some steam this morning before regaining some legs in the afternoon. The EUA Dec-24 ydy rallied 3.4% to EUR 53.97/ton in what looks like a short-covering-rally in both coal, nat gas, power and EUAs. This morning it gave almost all of the gains back again before regaining some strength in the afternoon to the point where it is now up at EUR 54.7/ton which is +1.4% vs. ydy. A weather forecast promising more seasonally normal temperatures and below normal winds could be part of the explanation.

The power market is currently the main driver and nat gas prices the most active agent. The main driver in the EUA market is the power market. When the EUA market is medium-tigh (not too loose and not too tight), then the EUA price will naturally converge towards the balancing point where the cost of coal fired electricity equals the cost of gas fired electricity. I.e. the EUA price which solves the equation: a*Coal_price + b*EUA_price = c*Gas_price + d*EUA_price where a, b, c and d are coefficients given by energy efficiency levels, emission factors and EURUSD fex forward rates. As highlighted earlier, this is not one unique EUA balancing price but a range of crosses between different efficiencies for coal power and gas power versus each other.

Coal-to-gas dynamics will eventually fade as price driver for EUAs but right now they are fully active. Eventually these dynamics will come to a halt as a price driver for the EUA price and that is when the carbon market (EU ETS) becomes so tight that all the dynamical flexibility to flex out of coal and into gas has been exhausted. At that point in time the marginal abatement cost setting the price of an EUA will move to other parts of the economy where the carbon abatement cost typically is EUR 100/ton or higher. We expect this to happen in 2026/27.

But for now it is all about the power market and the converging point where the EUA price is balancing the cost of Coal + CO2 equal to Gas + CO2 as described above. And here again it is mostly about the price of natural gas which has moved most dramatically of the pair Coal vs Gas.

Nat gas demand in Europe is running 23% below normal and inventories are way above normal. And natural gas prices have fallen lower and lower as proper demand recovery keeps lagging the price declines. Yes, demand will eventually revive due low nat gas prices, and we can see emerging signs of that happening both in Europe and in Asia, but nat gas in Europe is still very, very weak vs. normal. But reviving demand is typically lagging in time vs price declines. Nat gas in Europe over the 15 days to 25. Feb was roughly 23% below normal this time of year in a combination of warm weather and still depressed demand. Inventories are falling much slower than normal as a result and now stand at 63.9% vs. a normal 44.4% which is 262 TWh more than normal inventories.

Bearish pressure in nat gas prices looks set to continue in the short term. Natural gas prices will naturally be under pressure to move yet lower as long as European nat gas demand revival is lagging and surplus inventory of nat gas keeps rising rapidly. And falling front-end nat gas prices typically have a guiding effect on forward nat gas prices as well.

Yet lower nat gas prices and yet lower EUA prices in the near term most likely. Nat gas prices in Europe will move yet lower regarding both spot and forwards and the effect on EUA will be continued bearish pressure on prices.

EUA’s may struggle a bit to break below the EUR 50/ton line but most likely they will. EUA prices will typically struggle a bit to cross below EUR 50/ton just because it is a significant number. But it is difficult to see that this price level won’t be broken properly as the bearish pressure continues from the nat gas side of the equation. Even if nat gas prices comes to a halt at current prices we should still see the EUA price break below the EUR 50/ton level and down towards EUR 45/ton for Dec-24 and Dec-25.

The front-year nat gas price is the most important but EUA price should move yet lower even if it TTF-2025 stays unchanged at EUR 27.7/ton. The front-year is the most important for the EUA price as that is where there is most turnover and hedging. The following attractors for the EUA forward prices is with today’s TTF forward price curve (TTF Cal-2025 = EUR 27.7/ton) and today’s forward EURUSD FX curve and with ydy’s ARA coal closing prices. What it shows is that the forward EUA attractors are down at EUR 45/ton and lower.

The front-year Coal-to-Gas differential is the most important ”attractor” for the EUA price (Cal-2025 = average of Dec-24 and Dec-25) and that is down to around EUR 45/ton with a TTF Cal-2025 price of EUR 27.7/ton. The bearish pressure on EUA prices will continue as long as the forward nat gas prices are at these price levels or lower.

The front-year Coal-to-Gas differential is the most important "attractor" for the EUA price
Source: SEB graph and calculations, Blbrg data

And if we take the EUA attractors from all the different energy efficiency crosses between coal and gas then we get an average attractor of EUR 44.2/ton for EUA Cal-2025 (= average of Dec-24 and Dec-25) versus a market price today of EUR 53.9/ton.

Calculating all the energy efficiency crosses between coal and gas power plants with current prices for coal and nat gas for 2025 we get an average of EUR 44.2/ton vs an EUA market price of EUR 53.9/ton. Bearish pressure on EUAs will continue as long as this is the case.

Calculating all the energy efficiency crosses between coal and gas power plants with current prices for coal and nat gas
Source: SEB graph and calculations, Blgrg data

Utility hedging incentive index still deeply negative: Utilities have no incentive currently to buy coal, gas and EUAs forward and sell power forward against it as these forward margins are currently negative => very weak purchasing of EUAs from utilities for the time being. 

Utility hedging incentive index
Source: SEB calculations and graph, Blbrg data

Natural gas in Europe for different periods with diff between actual and normal decomposed into ”price effect” and ”weather effect”. Demand last 15 days were 23% below normal!

Natural gas demand in Europe
Source: SEB calculations and graph, Blbrg data

Natural gas inventories in Europe vs the 2014-2023 average. Surplus vs. normal is rising rapidly.

Natural gas inventories in Europe vs the 2014-2023 average. Surplus vs. normal is rising rapidly.
Source: SEB graph and calculations, Blbrg data

Nat gas inventories in Europe at record high for the time of year. Depressing spot prices more and more. Nat gas prices are basically shouting: ”Demand, demand, where are you?? Come and eat me!”

Nat gas inventories in Europe at record high for the time of year
Source: SEB graph and calculations, Blbrg data

Analys

OPEC+ won’t kill the goose that lays the golden egg

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Lots of talk about an increasingly tight oil market. And yes, the oil price will move higher as a result of this and most likely move towards USD 100/b. Tensions and flareups in the Middle East is little threat to oil supply and will be more like catalysts driving the oil price higher on the back of a fundamentally bullish market. I.e. flareups will be more like releasing factors. But OPEC+ will for sure produce more if needed as it has no interest in killing the goose (global economy) that lays the golden egg (oil demand growth). We’ll probably get verbal intervention by OPEC+ with ”.. more supply in H2” quite quickly when oil price moves closer to USD 100/b and that will likely subdue the bullishness. OPEC+ in full control of the oil market probably means an oil price ranging from USD 70/b to USD 100/b with an average of around USD 85/b. Just like last year.

Bjarne Schieldrop, Chief analyst commodities, SEB
Bjarne Schieldrop, Chief analyst commodities, SEB

Brent crude continues to trade around USD 90/b awaiting catalysts like further inventory declines or Mid East flareups. Brent crude ydy traded in a range of USD 88.78 – 91.1/b before settling at USD 90.38/b. Trading activity ydy seems like it was much about getting comfortable with 90-level. Is it too high? Is there still more upside etc. But in the end it settled above the 90-line. This morning it has traded consistently above the line without making any kind of great leap higher.

Netanyahu made it clear that Rafah will be attacked. Israel ydy pulled some troops out of Khan Younis in Gaza and that calmed nerves in the region a tiny bit. But it seems to be all about tactical preparations rather than an indication of a defuse of the situation. Ydy evening Benjamin Netanyahu in Israel made it clear that a date for an assault on Rafah indeed has been set despite Biden’s efforts to prevent him doing so. Article in FT on this today. So tension in Israel/Gaza looks set to rise in not too long. The market is also still awaiting Iran’s response to the bombing of its consulate in Damascus one week ago. There is of course no oil production in Israel/Gaza and not much in Syria, Lebanon or Yemen either. The effects on the oil market from tensions and flareups in these countries are first and foremost that they work as catalysts for the oil price to move higher in an oil market which is fundamentally bullish. Deficit and falling oil inventories is the fundamental reason for why the oil price is moving higher and for why it is at USD 90/b today. There is also the long connecting string of:

[Iran-Iraq-Syria/Yemen/Lebanon/Gaza – Israel – US]

which creates a remote risk that oil supply in the Middle East potentially could be at risk in the end when turmoil is flaring in the middle of this connecting string. This always creates discomfort in the oil market. But we see little risk premium for a scenario where oil supply is really hurt in the end as neither Iran nor the US wants to end up in such a situation.

Tight market but OPEC+ will for sure produce more if needed to prevent global economy getting hurt. There  is increasing talk about the oil market getting very tight in H2-24 and that the oil price could shoot higher unless OPEC+ is producing more. But of course OPEC+ will indeed produce more. The health of the global economy is essential for OPEC+. Healthy oil demand growth is like the goose that lays the golden egg for them. In no way do they want to kill it with too high oil prices. Brent crude averaged USD 82.2/b last year with a high of USD 98/b. So far this year it has averaged USD 82.6/b. SEB’s forecast is USD 85/b for the average year with a high of USD 100/b. We think that a repetition of last year with respect to oil prices is great for OPEC+ and fully acceptable for the global economy and thus will not hinder a solid oil demand growth which OPEC+ needs. Nothing would make OPEC+ more happy than to produce at a normal level and still being able to get USD 85/b. Brent crude will head yet higher because OPEC+ continues to hold back supply Q2-24 resulting in declining inventories and thus higher prices. But when the oil price is nearing USD 100/b we expect verbal intervention from the group with statements like ”… more supply in H2-24” and that will probably dampen bullish prices.

Not only does OPEC+ want to produce at a normal level. It also needs to produce at a normal level. Because at some point in time in the future there will be a situation sooner or later where they will have to cut again. And unless they are back to normal production at that time they won’t be in a position to cut again.

So OPEC+ won’t kill the goose that lays the golden egg. They won’t allow the oil price to stay too high for too long. I.e. USD 100/b or higher. They will produce more in H2-24 if needed to prevent too high oil prices and they have the reserve capacity to do it.

Data today: US monthly oil market report (STEO) with forecast for US crude and liquids production at 18:00 CET

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Analys

Prepare for more turmoil, lower inventories and higher prices

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Brent crude is pulling back below the 90-line this morning trading as low as USD 88.78/b following a 4.2% gain last week. The pullback is blamed on news that Israel is pulling some troops out of Gaza. But we think this is much more of a technical move below the 90-line with preparations for further price gains ahead. The Israeli troop movements are a preparation for a final push into Rafah in Gaza to take out the last stronghold of Hamas there (FT article today). Iranian retaliation following the attack in Damascus last week also looks set to unfold in some way. Possibly by Hezbollah in Lebanon though instigated by Iran. Prepare for more turmoil, lower oil inventories and higher prices as the market continues to run a deficit.

Bjarne Schieldrop, Chief analyst commodities, SEB
Bjarne Schieldrop, Chief analyst commodities, SEB

Brent gained 4.2% last week with a solid close above the 90-line. Brent crude had a stellar week last week gaining 4.2%. Even following such a strong performance it made a gain on Friday of 0.6% with a close at USD 91.17/b. Friday also saw the highest trade of the week at USD 91.91/b.

Brent was propelled by positive PMI gains, geopolitics and falling US inventories. Oil was supported by a rang of factors last week. Both the US and China saw their manufacturing PMIs rise above the 50-line (50.3 and 50.8 resp.). The Eurozone manufacturing PMI rose to 46.1 from 45.7 while the composite index rose above the 50-line to 50.3 from 49.9. These PMI gains supported both oil and metals through growth recovery optimism. US oil inventories last Wednesday created less waves with a net draw of 2.2 m b in total crude and product inventories. It was still a very bullish reading in our view as inventories normally this time of year should have risen 3.8 m b. Thus driving US commercial oil inventories further away and below the normal level of inventories. Geopolitical focus flared up following the attack on Iran’s consulate in Syria where Iran’s top Islamic Revolutionary Guard Corps (IRGC) general in Syria along with five other IRGC officers were killed. Israel is assumed to be behind the attack but has not taken responsibility yet.

Back below 90 this morning in what seems like a geopolitical breather. But is more of a technical move. This morning Brent crude has pulled back and traded as low as USD 88.78/b while trading at USD 89.76/b. We commented on Friday that it is quite normal for Brent crude to pull back below big numbers after having broken them. Just to test out the level properly before heading higher.

Israel is pulling some troops out of Gaza. Most likely it is preparing to attack Rafah (FT today)Price action to the downside this morning is blamed on some kind of reduced geopolitical premium as Israel is withdrawing some of its troops in Gaza. The reason why it is withdrawing some tropes however is to our understanding that Israel is preparing to attack Rafah, the southernmost part of Gaza bordering to Egypt where now close to one million Palestinians are living. It is the last strong-hold of Hamas and Israel looks bent on taking it out despite repeated warnings against it from the US. Human tragedy looks set to unfold in Rafah in not too long.

”Iran will respond to the Damascus strike”. The most likely flareup is Lebanon and Hezbollah. The geopolitical flare following the attack on Iran’s consulate in Syria last week has faded a little this morning. But this is in no way over. John Sawers, former chief of MI6, in an article in FT on Friday bluntly stated: ”Iran will respond to the Damascus strike”.  Iran still doesn’t want to be involved in direct military confrontation. The likely flareup will be Lebanon and Hezbollah which could force Israel into a two-front war. 

Rafah is located in the southernmost part of Gaza

Gaza map
Source: https://www.un.org/unispal/document/auto-insert-200679/

Net long specs in Brent + WTI rose by 34 m b over the week to 2 April.

Net long specs in Brent + WTI rose by 34 m b over the week to 2 April.
Source: SEB graph and calculations, Data feed by Bloomberg

Saudi Arabia lifted its Official Selling Prices to Asia for most grades for May delivery

Saudi Arabia lifted its Official Selling Prices to Asia for most grades for May delivery
Source: SEB graph and calculations, Data feed by Bloomberg
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Analys

Brent crude jumps above USD 91/b as market nervously brace for Iranian retaliation

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Brent crude jumps above USD 91/b but will likely see sub-90 again before charging yet higher. Brent crude reached USD 89.99/b on Wednesday before making the leap above the 90-line yesterday evening in a spiky fashion jumping almost directly to USD 91.3/b (ydy high) in less than three hours before closing at USD 90.65/b. This morning it is showing strength again with a gain of 0.6% to USD 91.2/b though it hasn’t yet broken above the high from ydy. It is very usual for the oil price to fool around big numbers as the 90-line before properly breaking through. We saw it on Wednesday when it almost got there but not really above anyhow. Also after breaking properly above as it did yesterday one often sees that the oil price then dips down to the ”big number” again, a little bit below, just to test it, before properly breaking higher. Thus we’ll likely see it break down below the 90-line again in the short-term before heading properly higher.

Bjarne Schieldrop, Chief analyst commodities, SEB
Bjarne Schieldrop, Chief analyst commodities, SEB

Iran promises retaliation while Israel makes it clear it will strike back if attacked. Iran’s top Islamic Revolutionary Guard Corps (IRGC) general in Syria along with five other IRGC officers were killed on Monday following an attack on Iran’s consulate in Syria. Iran has blamed Israel for the attack. Israel has so far not taken responsibility for the attack. Iran’s President Ebrahim Raisi directly blamed Israel and stated on Tuesday that Israel’s strike on its consulate in Syria ”won’t remain unanswered”. Yesterday we saw a hard-line stand from Israel where Netanyahu made it clear that if Iran strikes its territory then Israel will have no choice but to respond.

Market is preparing for Iranian retaliation, but most likely it will be through Iran’s proxies. The market is now bracing it self for a likely retaliatory action by Iran in response to the event in Syria on Monday. It seems very unlikely that Iran explicitly will attack targets on Israeli soil directly and thus risk getting dragged into a wider war with Israel and thus the US. If Israel and Iran gets into a direct conflict then the US will naturally be involved either directly or indirectly. No one wants that. Not Iran, not Biden and not Israel. A forthcoming retaliatory attack from Iran will thus likely be through some of its proxies in Yemen, Syria or Lebanon.

The market now know that some kind of retaliation from Iran will likely come but it doesn’t know when and where and what and that creates a great discomfort and nervousness.

Oil supply is unlikely to be affected. Still no one expects that oil supply is at risk in any way unless this situation blows out to an all-engulfing conflict between Israel and Iran where the US naturally would be dragged along into it all. It is too much at stake for all parties involved for this to happen.

Iran is producing 3.1 m b/d and rising and is unlikely to endanger that. Iran is probably extremely happy at the moment with respect to oil prices and oil exports. Iran used to produce around 3.8 m b/d of crude oil but due to US sanctions it only produced 2.0 m b/d in 2020 which is basically what it needs to cover its own demand with little left over for exports except for condensates which comes on top of crude oil production with about 0.8 m b/d. Since 2020 however its production has increased significantly and now stands at 3.1 m b/d and rising. Add in an oil price of USD 91/b and the situation for Iran is close to bliss economically. So Iran will likely retaliate following the attack on its consulate in Syria on Monday, but not in a fashion which will endanger its greatly improved situation with respect to oil export income.

Iran’s oil production is now back up to 3.1 m b/d and rising. Economically this is bliss for Iran when added together with an oil price of USD 91/b

Iran's oil production
Source: SEB graph, Blbrg data

The ongoing destruction of Gaza following the October 7 attack on Israel will feed red hot anger, pain and violence into the Middle East region for months and years to come.

Gaza
Source: Photo by: France24
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