Analys
Buying EUAs on the cheap will likely be one of the great opportunities of 2024
There are certainly bearish forces at work in the EUA market currently. Spot-wise, yes, but current forward price curve dynamics also creates a bearish pressure. Not the least from the utility side which normally is the big forward buyer of EUAs. They can now buy back previous forward hedges which where they locked in positive forward power margins. The can now instead reverse these which means that they instead of buying EUAs forward will sell EUAs forward.
That said, the MSR mechanism in the EUA market basically ensures that any surplus EUA above 833 million ton in the TNAC (Total Number of Allowances in Circulation) is wiped out within 2-3 years. The medium term EUA market fundamentals in 2026/27 and beyond is thus mostly untouched of what is going on right now. Forward 2026/27 and onward fundamentals are thus still as strong as they were previously which calls for a minimum price of EUR 100/ton or more by that time-horizon.
The question is what will be the catalyst which will turn this around to bullish price action instead of current bearish price action. A return to positive, forward clean dark and clean spark spreads is one. Economic revival in Europe as nat gas prices now have come down almost to the real average gas price level from 2010 to 2019 is another. Strong buying from shipping as they have no free allocations on their hands and will need every single EUA they buy in the years to come. But also industry will need increasingly more EUAs in the years to come and could utilize the current slump in EUA prices. Investors could also dive in at price levels seen ”too low” versus medium-term fundamental prices. Though hedge funds rarely have time to wait 2-3 years for a revival. But at some point the difference between the EUA spot price and what is considered a fair EUA price level (given politics and forward EUA fundamentals) become too big and too tempting to resist for both speculators and users of EUAs
Every year has unique opportunities in different types of assets, equities, currencies etc. We think that one of the great opportunities in 2024 when looked upon in hindsight, will be cheap EUAs. Thus those in need for EUAs in the years ahead should bid their time and pay attention to the opportunity currently playing out in the EU carbon market.
Since 17 January the front-month EUA price has ranged between an intraday low of EUR 59.12/ton and an intraday high of EUR 64.05/ton and with an average of closes of EUR 61.4/ton. The stabilization in the EUA price seems strongly related to the price development in the front-year TTF nat gas price which has stabilized at around EUR 32/MWh during the exact same period following a sharp price decline since early October last year.
The front-year TTF nat gas contract has stabilized at around EUR 32/MWh and the average year 2025 EUA price has stabilized for now around EUR 61/ton.
But the EUA price may have halted around the EUR 60/ton mark for other reasons as well. One is that when politicians tightened up the EUA market with backloading (2014) and MSR (2019) the EUA price rallied on its own merits and ahead of the Coal-to-Gas differentials all the way up to EUR 60/ton in 2021. In September 2021 however the C-t-G differentials (implied price of EUAs by marginal power market dynamics in an EUA market which is not too tight and not too loose) rallied ahead and above the EUA price due to the rally in nat gas prices. This then helped to drive the EUA price yet higher. The EUA price is now however back down at the crossover price of EUR 60/ton from September 2021 at which the EUA price previously was able to reach on its own merits (political tightening).
The average EUA front-year price in EUR/ton vs. the implied front-year C-t-G differential with 41% efficient coal and 54% efficient nat gas. The difference between the efficiency of 41% to 54% is not much different than the often used 36% vs 49%.
The EUA price also seems to follow the front-year C-t-G differentials quite closely while the discrepancies widen out further out on the curve. Thus a further sharp decline in the front-year TTF nat gas price is probably needed dynamically to drive the EUA price yet lower.
The EUA price seems to be anchored to the front-year TTF nat gas price as well as the front-year Coal-to-Gas differentials. But further out on the curve the latter widens out. Either because of increasing market tightness or simply due to curve structures. There are no support from C-t-G differentials in the current forward curves for 2026 and 2027.
A serious element of weakness in the EUA market currently is that current forward clean power margins are negative. I.e. there is likely very limited amount of forward hedging by utilities as it doesn’t make sense for utilities to lock-in negative forward margins. Utilities are normally a large source of forward buying of EUAs and now there is probably close to nothing. And maybe even the opposite: Utilities may reverse previously entered hedges where they locked in forward positive margins and now instead can buy them back at favorable negative levels.
On a forward basis it costs more to produce power with Coal+CO2 or Gas+CO2 than it is possible to sell the power at on a forward basis.
The following graph shows a ”utility hedging incentive index” which when positive indicates positive, clean forward coal and gas power margins with a weighting of 75%, 50% and 25% on the nearest Yr1, Yr2 and Yr3. Very strong and positive forward power margins since Jan 2019. The index crossed below the EUR 5/MWh margin October last year and now sits at a massive negative EUR 7.8/MWh at which Utilities are incentivised to revers their previous hedges and buy back previously sold power and then sell coal, gas and EUAs.
The EUA price vs. SEB’s Utility forward hedging incentive index. Now very negative. Potentially feeds EUA sales into the market from the Utility side.
There are thus certainly bearish forces at work in the EUA market currently. Both spot-wise but also current forward price curve dynamics creates a bearish pressure. Not the least from the utility side which normally is the big forward buyer of EUAs.
That said, the MSR mechanism in the EUA market basically ensures that any surplus EUA above 833 million ton in the TNAC (Total Number of Allowances in Circulation) is wiped out within 2-3 years. The medium term EUA market fundamentals in 2026/27 are thus mostly untouched of what is going on right now. Forward 2026/27 and onward fundamentals are thus still as strong as they were previously which calls for a minimum price of EUR 100/ton or more by that time-horizon.
The question is what will be the catalyst which will turn this around to bullish price action. Positive, forward clean dark and clean spark spreads is one. Economic revival in Europe as nat gas prices now have come down almost to the real average gas price level from 2010 to 2019. Strong buying from shipping as they have no free allocations on their hands and will need every single EUA the buy in the years to come. But also industry will need increasingly more EUAs in the years to come. Investors could also dive in at price levels seen ”too low” versus medium-term fundamental prices. Though hedge funds rarely have time to wait 2-3 years for a revival. But at some point the difference between the EUA spot price and what is considered a fair EUA price level (given politics and forward EUA fundamentals) become too big and too tempting to resist for both speculators and users of EUAs
Brent touching down to the 200dma. Brent crude traded down for a fifth day yesterday with a decline of 0.4% to USD 70/b. This morning it has traded as low as USD 78.6/b and touched down and tested the 200dma at USD 78.6/b before jumping back up and is currently trading up 0.2% on the day at USD 79.1/b.
The Dubai 1-3mth time-spread is holding up close to recent highs. The 1-3mth time spreads for WTI and Brent crude have eased significantly. The Dubai 1-3mth spread is however holding up close to latest high. Indian refiner Bharat is reported to struggle to get Russian crude for March delivery (Blbrg). The Biden-sanctions are clearly having physical market effects. So, the Dubai 1-3mth time-spread holding on to recent high makes a lot of sense. I.e. it was not just a spike on fears.
US oil inventories may have risen 6 mb last week (API). Actual data later today. The US DOE will release US oil data for last week later today. The US API last night indicated that US crude and product stocks may have risen close to 6 mb last week. This may be weighing on the oil price today.
Brent and WTI 1-3mths time-spreads have fallen back while Dubai is holding up
Brent crude is no longer overbought. Down touching the 200dma before bouncing back up a lilttle.
Analys
Crude oil comment: Deferred contracts still at very favorable levels as latest rally concentrated at front-end
Bouncing up again after hitting the 200dma. Bitter cold winter storm in Texas adding to it. Brent crude continued its pullback yesterday with a decline of 1.1% to USD 79.29/b trading as low as USD 78.45/b during the day dipping below the 200dma line while closing above. This morning it has been testing the downside but is now a little higher at USD 79.6/b. A bitter cold winter storm is hitting Texas to Floriday. It is going to disrupt US nat gas exports and possibly also US oil production and exports. This may be part of the drive higher for oil today. But maybe also just a bounce up after it tested the 200dma yesterday.
Some of the oomph from the Biden-sanctions on Russia has started to defuse with arguments running that these sanctions will only delay exports of Russian crude and products rather than disrupt them. The effects of sanctions historically tend to dissipate over time as the affected party finds ways around them.
Donald criticizing Putin. Biden-sanctions may not be removed so easily. In a surprising comment, Donald Trump has criticized Putin saying that he is ”destroying Russia” and that ”this is no way to run a country”. Thus, Donald Trump coming Putin to the rescue, removing the recent Biden-sanctions and handing him a favorable peace deal with Ukraine, no longer seems so obvious.
Deeper and wider oil sanctions from Trump may lift deferred contracts. Trump may see that he has the stronger position while Putin is caught in a quagmire of a war in Ukraine. Putin in response seems to seek closer relationship with Iran. That may not be the smart move as the US administration is working on a new set of sanctions towards Iranian oil industry. We expect Donald Trump to initiate new sanctions towards Iran and Venezuela in order to make room for higher US oil production and exports. That however will also require a higher oil price to be realized. On the back of the latest comments from Donald Trump one might wonder whether also Russia will end up with harder sanctions from the US and lower Russian exports as a result and not just Iran and Venezuela. Such sanctions could lift deferred prices.
Deferred crude oil prices are close to the 70-line and are still good buys for oil consumers as uplift in prices have mostly taken place at the front-end of the curves. Same for oil products including middle distillates like ICE Gas oil. But deeper and lasting sanctions towards Iran, Venezuela and potentially also Russia could lift deferred prices higher.
The recent rally in the Dubai 1-3 mth time-spread has pulled back a little. But it has not collapsed and is still very, very strong in response to previous buyers of Russian crude turning to the Middle East.
The backwardation in crude is very sharp and front-loaded. The deferred contracts can still be bought at close to the 70-line for Brent crude. The rolling Brent 24mth contract didn’t get all that much lower over the past years except for some brief dips just below USD 70/b
ICE Gasoil rolling forward 12mths and 24mths came as low as USD 640/ton in 2024. Current price is not much higher at USD 662/ton and the year 2027 can be bought at USD 658/ton. Even after the latest rally in the front end of crude and mid-dist curves. Deeper sanctions towards Iran, Russia and Venezuela could potentially lift these higher.
Forward curves for Brent crude swaps and ICE gasoil swaps.
Nat gas front-month getting costlier than Brent crude and fuel oil. Likely shifting some demand away from nat gas to instead oil substitutes.
Brent crude was already ripe for a correction lower. Brent closed down 0.8% yesterday at USD 80.15/b and traded as low as USD 79.42/b intraday. Brent is trading down another 0.4% this morning to USD 79.9/b. It is hard to track and assign exactly what from Donald Trump’s announcements yesterday which was impacting crude oil prices in different ways. But crude oil was already ripe for a correction lower as it recently went into strongly overbought territory. So, Brent would probably have sold off a bit anyhow, even without any announcements from Trump.
Extending the life of US oil and gas. The Brent 5-year contract rose yesterday. For sure he wants to promote and extend the life of US oil and gas. Longer dated Brent prices (5-yr) rose 0.5% yesterday to USD 68.77/b. Maybe in a reflection of that.
Lifting the freeze on LNG exports will be good for US gas producers and global consumers in five years. Trumps lifting of Bidens freeze on LNG exports will is positive for global nat gas consumers which may get lower prices, but negative for US consumers which likely will get higher prices. Best of all is it for US nat gas producers which will get an outlet for their nat gas into the international market. They will produce more and get higher prices both domestically and internationally. But it takes time to build LNG export terminals. So immediate effect on markets and prices. But one thing that is clear is that Donald Trump by this takes the side of rich US nat gas producers and not the average man in the street in the US which will have to pay higher nat gas prices down the road.
Removing restrictions on federal land and see will likely not boost US production. But maybe extend it. Donald Trump will likely remove restrictions on leasing of federal land and waters for the purpose of oil and gas exploration and production. But this process will likely take time and then yet more time before new production appears. It will likely extend the life of the US fossil industry rather than to boost production to higher levels. If that is, if the president coming after Trump doesn’t reverse it again.
Donald to fill US Strategic Reserves to the brim. But they are already filled at maximum rate. Donald Trump wants to refill the US Strategic Petroleum Reserves (SPR) to the brim. Currently standing at 394 mb. With a capacity of around 700 mb it means that another 300 mb can be stored there. But Donald Trump’s order will likely not change anything. Biden was already refilling US SPR at its maximum rate of 3 mb per month. The discharge rate from SPR is probably around 1 mb/d, but the refilling capacity rate is much, much lower. One probably never imagined that refilling quickly would be important. The solution would be to rework the pumping stations going to the SPR facilities.
New sanctions towards Iran and Venezuela in the cards but will likely be part of a total strategic puzzle involving Russia/Ukraine war, Biden-sanctions on Russia and new sanctions on Iran and Venezuela. All balanced to end the Russia/Ukraine war, improve the relationship between Putin and Trump, keep the oil price from rallying while making room for more oil exports of US crude oil into the global market. Though Donald Trump looks set to also want to stay close to Muhammed Bin Salman of Saudi Arabia. So, allowing more oil to flow from both Russia, Saudi Arabia and the US while also keeping the oil price above USD 80/b should make everyone happy including the US oil and gas sector. Though Iran and Venezuela may not be so happy. Trumps key advisers are looking at a big sanctions package to hit Iran’s oil industry which could possibly curb Iranian oil exports by up to 1 mb/d. Donald Trump is also out saying that the US probably will stop buying oil from Venezuela. Though US refineries really do want that type of oil to run their refineries.
Big money and USD 80/b or higher. Donald Trump holding hands with US oil industry, Putin and Muhammed Bin Salman. They all want to produce more if possible. But more importantly they all want an oil price of USD 80/b or higher. Big money and politics will probably talk louder than the average man in the street who want a lower oil price. And when it comes to it, a price of USD 80/b isn’t much to complain about given that the 20-year average nominal Brent crude oil price is USD 77/b, and the inflation adjusted price is USD 102/b.
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