European carbon permit prices, which have tripled in value over the past year, are likely approaching a peak and expected to decrease by December, according to a Bloomberg survey. The surge in prices, driven by anticipation of reduced supply in 2019, has made carbon permits the best-performing major commodity. However, market analysts and traders predict a decline in prices due to various factors, including selling by new traders, increased wind and solar power generation, and negative margins from fossil fuel power generation.
Market Outlook:
The survey, conducted among nine traders and analysts, suggests that while carbon permit futures could still rise by 4.2 per cent by the end of this month, they are likely to slide by 5.2 per cent by December. Market participants believe that emitters and speculators have already purchased permits in anticipation of the lower supply expected next year. Additional factors contributing to the expected decline include selling pressure from new market entrants and the high levels of renewable energy generation, which could reduce the demand for carbon permits. Louis Redshaw, the founder of Redshaw Advisors Ltd., highlights the potential pressure at the end of the year that could further drive down prices.
Market Dynamics and Policy Changes:
The European carbon market, valued at $35 billion, has attracted various participants, including cement makers and hedge funds, as recent regulatory interventions aimed at boosting prices have yielded results. Lawmakers have decided to decrease the supply of permits from next year and establish a reserve to support price increases, encouraging utilities to reduce their reliance on coal. While permits were initially distributed for free in 2005, utilities have been mandated to purchase them since 2013 as pollution regulations have become more stringent. The expected revenue from this year’s allowances is estimated to reach a record 14.5 billion euros ($17 billion) based on current prices and volume forecasts.
Price Projections and Market Behaviour:
The median estimates from the survey indicate that prices will rise to 16 euros per metric ton by the end of the month before declining to 14.55 euros by the end of the year. However, Markus Krebber, CFO of RWE AG, the largest emitter in the region, suggests that market participants’ behaviour will be a crucial factor. While a surplus still exists, if market participants are unwilling to sell their permits, there could be a physical squeeze leading to significant price spikes. Analysts also point to the options market, which may contribute to price declines. As prices have surged, sellers of call options may have bought futures as a hedge, increasing demand. Once these options holders take delivery of permits, some may choose to sell, not wanting to hold them as long-term investments.
Implications for Utilities and Coal Plants:
The challenging financial situation for utilities operating coal and gas power plants, coupled with declining carbon prices, may incentivize some utilities to reduce their reliance on fossil fuel power generation. This shift could potentially improve profitability for coal and gas plants.
Conclusion:
While European carbon permits have experienced an impressive rally, market experts anticipate a price decline by the end of the year. Factors such as new market entrants, increased renewable energy generation, negative margins for fossil fuel power generation, and options market dynamics contribute to this outlook. The behaviour of market participants and the balance between supply and demand will play a crucial role in determining the future trajectory of carbon permit prices in Europe.
