Friday’s end of day settlement price for a UK ETS allowance futures contract was £55.16, up from a low of 42.40 in July. EU ETS prices are also at historic heights, hitting a record of £62.75 per tonne earlier this month.
According to ICE, which auctions UK ETS allocations on behalf of the government, the market hit record volume and open interest on Thursday, with participants seeking to hedge against the risk of prices reaching even higher levels. A total of 6,388 allowance futures were traded, with open interest reaching an equivalent equivalent of 23,534 tonnes of CO2.
The prospect of the regime’s cost containment mechanism being activated is looking more likely. The threshold price for September is £45.90, with the average so far this month being £53.52. The price could still fall but remain above the trigger prices for October and November, of £50.37 and £53.88, respectively.
But there will be no government intervention until the end of the year at the earliest. The earliest that the mechanism could be triggered – injecting more allowances into the market to cool demand – is December, as it requires three consecutive months where the thresholds are exceeded.
Prices at auction are also on the up. The last to be held was on 8 September, recording a record clearing price of £53.25, raising £276m. Reflecting demand, bids were made for over 9.5m allowances. The next auction will be held on Wednesday, from midday to 2pm, with 5,187,500 allowances again on offer.
The price rises have been sparked by increasing demand for allowances, as the power sector falls back on carbon-intensive coal generation due to record natural gas prices. European stocks of gas are low and demand is high in Asia as economies begin to recover from the grip of the pandemic. This has all pushed up how much the market is willing to pay for gas. The wholesale price in the UK has risen by 70% since August, according to industry group Oil & Gas UK.
There have been signs of a crunch for some time – in July, the futures contract to deliver gas to the UK this winter hit the highest level since records began.
The high cost of gas has in turn pushed up the wholesale price of electricity to record levels.
“Market participants live in hope for that containment mechanism to be triggered,” Louis Redshaw, chief executive of carbon market experts Redshaw Advisors, told ENDS, as the short to medium-term supply of allowances is less than demand. This is despite the overall ETS annual emissions cap being significantly more than anticipated demand – the subject of an unsuccessful legal challenge.
He blamed the seemingly contradictory facts on the hiatus in emissions trading earlier this year, with bids for UK allowances only opening in May after the UK left the EU mechanism. Redshaw added that he expects the position to remain for at least a year, assuming no change to the scheme, despite “relatively large” auctions injecting liquidity into the market.
Another issue is that what exactly would happen if the mechanism is triggered continues to be uncertain, which ““does not fill industry with confidence”, he claimed.
More generally, the UK ETS presents a “massive wasted opportunity” for UK industry to have a competitive advantage while decarbonising, Redshaw said, arguing that UK allowances should be trading at a discount to their EU equivalent, yet are not due to auctions being poorly designed.
There is now a “Catch 22 situation” whereby UK utilities are selling off their stocks of EU allowances to buy UK allowances, which are getting dragged up with them in turn, he added.
“While we are not complacent, we do not expect supply emergencies this winter,” the government said in a statement on Friday, as business secretary Kwasi Kwarteng held emergency talks with energy industry heads.
He is also chairing a roundtable meeting today, after some gas and power suppliers have gone broke and others are seeking a bailout to avoid the same fate. Kwarteng is reportedly considering establishing a ‘bad bank’ for the sector, on the lines of how the financial crisis was dealt with a decade ago.
Redshaw suggested that the UK could take a leaf out of Spain’s book, by redirecting cash raised from ETS auctions to subsidising retail customers’ rising energy bills.
Speaking from New York, ahead of the UN General Assembly this week, prime minister Boris Johnson sought to reassure the country that the problems were purely temporary.
The situation in the UK has been made worse due to power stations being out for maintenance, low wind speeds and a fire that has knocked out an interconnector to French nuclear power – while another was out of commission. It has led to an unusually low margin between generation capacity and demand.
The shutdown of fertiliser plants caused by the spike in power prices has also led to the loss of bottled CO2, vital for the preservation of food products – an industry already hit by a shortage of lorry drivers.
“This is really a function of the world economy waking up after Covid. “We’ve got to try and fix it as fast as we can, make sure we have the supplies we want, make sure we don’t allow the companies we rely on to go under. We’ll have to do everything we can. But this will get better as the market starts to sort itself out, as the world economy gets back on its feet,” he said.