EU Carbon Market ‘Gap’ Shows Futures Could Go Even Higher

(Bloomberg) -- The past week’s bull run in European Union carbon allowances to their highest level in more than 10 years could extend into this week, with trading patterns indicating strong demand.

Mark Lewis, global head of sustainability research at BNP Paribas SA’s asset management unit, points to a gap in trading on Wednesday, a technical pattern that highlights the difference between the high and low on two consecutive trading days.

The chart below shows there was a spread of 8 cents from the high on Tuesday to the low on Wednesday. The gap appeared as concern about a no-deal Brexit waned, and was followed by two days of surges. A gap is a technical signal that typically occurs when lots of buyers or sellers move into a security.

“The way the market gapped Wednesday shows there’s quite a bit of short covering,” said Lewis, a veteran analyst in the market.

Factories and power stations may not sell the allowances they hold into the market because they’re saving them for future years. At the same time, hedge funds have bought into the market, seeking trading profits.

Utilities may switch to cleaner gas from dirtier coal to keep carbon from rising and save using too many of their increasingly expensive allowances. Fuel prices indicate carbon may need to rise above 40 euros a ton by next winter from 26 euros ($34) currently to spur a switch that lowers emissions enough to bring the CO2 market toward equilibrium, Lewis said.

So carbon may keep surging. Emitters need to hand in allowances by the end of this month to match 2018 emissions, which means that those who haven’t got enough permits to cover their emissions will have to buy more.

“Short covering drives prices higher again -- you do tend to see compliance buyers who’ve been caught out or don’t have enough coming into the market and buying ahead of the deadline,” Lewis said.

Brexit Risk Fading

With the risk receding of the U.K. crashing out of the European union, and its carbon market, there’s less likelihood that the nation’s factories will sell their permits at once.

Lewis isn’t the only bull. Berenberg Bank, Energy Aspects Ltd. and BloombergNEF are among analysts who’ve said prices could surge further. This is because the EU has cut supply in auctions this year by about 40 percent, creating a facility known as the market stability reserve to deal with the long-term glut.

The system is an additional way of keeping allowances away from the traded market, gradually removing more of them over the next few years.

“There is a relentlessness to the market stability reserve,” Lewis said. “The MSR is a really big deal because it’s going to squeeze supply massively.”

And options are also showing the bullish sentiment of the market, having their third best week ever, with more calls being traded than puts.

--With assistance from Helen Robertson.

To contact the reporter on this story: Mathew Carr in London at m.carr@bloomberg.net

To contact the editors responsible for this story: Reed Landberg at landberg@bloomberg.net, Lars Paulsson, Andrew Reierson

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