UK: INSIDE OR OUTSIDE THE EU ETS SYSTEM. WHAT IS EXPECTED IN CARBON PRICES?

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UK: INSIDE OR OUTSIDE THE EU ETS SYSTEM. WHAT IS EXPECTED IN CARBON PRICES?

On the afternoon of January 15 the parliament of the United Kingdom (UK) voted no to the Brexit agreement of Theresa May. A battle lost with a large margin of votes: 432 against 202. An expected result as the carbon prices showed little reaction the following morning.

The possible scenarios for Brexit at this point are multiply, especially for British politicians. A complicated situation for UK participants in the European Union (EU) ETS market. UK is the second country in Europe that emits the most C02. Specifically, its thermal generation plants are among the largest buyers of EU emission rights. UK auctions represent 10% of the total supply of rights for auctions. It is expected that the EU ETS market will not be as efficient without the UK.

Despite the difficulty that the Brexit is experienced, the possible scenarios for the European carbon market are only three for this year 2019: A hard Brexit – without agreement, a soft Brexit – with agreement and a non Brexit.

A year with a weak start for the market after triple its price in 2018. The low participation in auctions seems to have stabilized the price between € 23 / MWh. This behaviour may be a sign that the participants prepared themselves  in 2018for the start of the MSR. Be informed that the MSR must absorb a third of the EUA supply volume auctioned in 2019.

Source: M-Tech

In this context, let’s review the scenarios and their impact on the EU ETS market for this year 2019.

A HARD BREXIT

In this scenario UK leaves the EU as well as its ETS market. UK participants will not have to report or be obliged to comply with the EU ETS market beyond 2018. Therefore, UK account holders as well as companies with cumulative surplus for 2018 of allowances will need to offload them. The volume of EUAs to be delivered is estimated at 85 million. They will have to either sell them or transfer them to other branches of the same company that are in another EU site. Another option is to transfer them to a newly created account in other national sections of the European register.

In return, British companies would have to pay a carbon tax from April 1 whose objective is to replace the EUA-cost.

Consequently, a Brexit without agreement would cause a drop in US prices in the short term as participants with excesses of EUAs should get rid of them as well as unwind their hedges. However, the downward effect would be limited since UK multinational companies have the option of transferring the surplus to other subsidiaries in Europe for later use. Moreover, the bearish effect would be more pronounced because of the impact of a hard Brexit on the European economy, affecting all markets, and it would also spill over the carbon market. This effect would be more significant in carbon prices than the EUAs movement from UK companies to get rid of them.

A BREXIT WITH AGREEMENT

In this scenario, the UK would come out of the European Union’s ETS system orderly until the end of 2020. The UK companies would have an obligation to comply with the EU ETS by 2019 and 2020. That is, the EUA auctions in the UK will be reopened once the “Brexit” withdrawal agreement is ratified between the United Kingdom and the European Union. Thus, UK can assign free rights for companies as always in those years. On the other hand, British generators will be able to slow down their hedging until they have the visibility of their necessary obligations. In fact, the hedge ratios of UK power producers have already been reduced. A cautious measure to the Brexit uncertainty.

With a smooth Brexit, no impact on carbon prices is discerned, assuming participants will have time to plan their exit from the EU ETS system before 2020. A desired scenario by the main ETS agents in the UK, since they wish to avoid risks with their compliance obligation.

A NO BREXIT

In this scenario, the United Kingdom decides to revert the Brexit and remains in the European Union as well as in its ETS system. The UK government would revoke article 50 resulting in a new referendum.

In this scenario a bullish effect is foreseen since the UK participants will likely need to increase their EUA buying to catch up with the necessary hedging. An additional purchase is also likely to happen from the UK industry participants. All this would give an upward boost to the market. In addition, auctions and allocations of rights in the UK, currently suspended, would be resumed.

CURRENTLY

Today the UK parliament votes again Teresa May’s withdraw agreement from the European Union. Market participants remain cautious although the pound gained ground in the expectation that the necessary support to pass the vote will be achieve. Although Tory Brexiteers still denounce the solution for the Irish border, some Tory Brexiteers leaders Torys indicated they will support Theresa May. A support that is given if adding a codicil to guarantee that a possible “temporary customs union” will not become permanent. A codicil that would also be accepted by the European Union instead of renegotiating the current withdrawal agreement.

Today almost twenty amendments are voted on the UK parliament. One of them, belonging to Labor Yvette Cooper, has the support among pro-European conservatives and demands Theresa May to request an extension to Brussels for Article 50 of the Treaty of Lisbon. If the departure date is postponed the auctions and assignments of allowances in the UK will still be suspended for the entire first quarter of the year. Plus, British companies could change their strategy and start buying the EUAs that they had postponed as the low demand of auctions from the continent imported to the UK have shown. If they start buying without having any UK supply coming to market, a potentially bullish for carbon price could take place.

To summarize: in the scenario of a hard Brexit, the carbon price  would fall, and in the scenario of a No Brexit or a postponed Brexit the carbon price would rise while in the scenario of a soft Brexit there would be no impact. As for the level of price variations, both downwards and upwards, it would be difficult to determine how much but it is not foreseen that they will be 2018 price curve.

Marta Merodio | Energy Consultant

By | 2019-01-29T09:54:48+00:00 January 29th, 2019|Categories: Coal, Energy Markets, Energy Policies, M·Blog|Tags: , , |Comments Off on UK: INSIDE OR OUTSIDE THE EU ETS SYSTEM. WHAT IS EXPECTED IN CARBON PRICES?