The Calm Before 2026: EUAs, Investors & Policy Expectations

[MUSIC] Welcome to Carbon Trading Chronicles, the podcast that untangles the complexities and potentials of emissions trading. Whether you're an industry expert or simply curious about how emissions trading supports the energy transition, this podcast is your platform to join the conversation. [MUSIC] Welcome back to Episode 2 of the Carbon Trading Chronicles. The number one podcast on Carbon Trading in the world. And today we have a very special guest. If you don't know her, well, it means you've not been in Carbon for long enough. Julia, pleasure to have you. >> Thanks for having me. >> So just for those that don't know where you've been or where you've been for the last couple of years, you just started a new venture with Latis. >> Exactly. Yeah, so Latis is like you said, it's brand new. We actually launched a couple of weeks ago. We were a new investment in trading company. >> Great. >> With a thesis to invest in infrastructure assets and combine it with trading. And the idea is those two things together kind of bring excess returns. >> Little bit of physical and mix. And of course, we also have Reham as always from Bertis and Vierman, Tell of Finance. >> Good to see you, Stefan. >> Let's hit it off right away. The Carbon market has been very interesting in the last couple of weeks. Julia, are you bullies or bearish? >> I have got to say I'm bullish. It's hard to be bearish here, right? >> It is very hard to be bearish, I think, especially, well, it's tricky because we're in this battle with gas. I feel at the moment with gas being so bearish. >> Right. >> The EUAs are sort of-- >> And we're going to go there, right? But is it really a battle or is it just like carbon being finally back on its own feet? >> I think so. I think it's like it's destiny, basically, given the supply outlook of the next two years. >> It feels good as an analyst in this market and you know how we've spoken about maybe a year or two ago and when we said we were not carbon analysts, we were basically gas analysts. And to be finally back in our turf, what about you? >> I'm cautiously bullish again. >> cautiously bullish? >> Again, yeah, because last time I was like this and I think it was a-- >> For the meeting short, midterm. >> Yeah, midterm, I think into this end of this year and like start next year. I'd be cautiously bullish just because there are a lot of pieces that might be changing and in terms of positioning, in terms of like option markets and all of these things like how these things would evolve in the next year. That's a different story for me. >> Right. I hate being-- you know, swimming with the current, but I'm also cautiously bullish. >> Copycat. >> But I really wonder if we zoom out a little bit. You had hedge funds majorly positioning themselves lately on the bullish side. Yet, and we're going to speak about that more industrial buying, I think has dried out here. A lot seems to depend on the weather. What are you making of the market, let's say, in the shorter time frames, over the winter? Is it just a weather trade for you? >> Yeah, I mean, the specs are a major component, as you mentioned. I thought it was interesting how they built their length at the same time when what we thought was sort of the ignite hedges unwinding, the latter part of the summer. >> Which is maybe a reason why the price didn't react that much to the right. Because otherwise you would have expected 100 million net long should have ripsed for them. >> Absolutely. So, you know, the fact that the low 80s still is very interesting. We obviously have the moment like gas is reacting to weather much more than EUAs. So, I think it really is a question of what specs will do. >> This is almost weather is a factor for EUAs as soon as it's dunkelflalte or cold, right? So, it goes upwards, but it doesn't come downwards really. >> Yeah, it has been very mild this winter so far though, right? >> Yeah, so far. And still everyone is cared of. >> But there's something that I heard recently from people working at utilities. They were saying that there are still pricing in a risk for a cold winter. >> Especially January, right? >> Yeah, especially January. This is what we heard on the market basically. So, on the street people are pricing in this risk and they are saying that it might turn to be colder. It's been milder so far. Yes, we had two cold spells, I guess. >> But it's too early, right? I mean, if we were in January right now and we are mild, then that's when we get those sell-offs in February, right? >> Yeah. >> When it's mild and that's it kind of. But it's still too early. So, it makes sense that it's asymmetrically shifted towards if it's cold and everyone freaks out. But if it's mild, well, that's okay, ish. And I think the real question is sort of how do utilities hedge and actually you might know more from your history. But if they hedge to seasonal normal, then as we out-turned-mile, you're kind of chopping your hedges continuously. But I almost feel like EUAs, I mean, looking at the supply picture into next year, it's almost a little bit irrelevant to an extent what weather does. Gas is obviously going to do. >> It's a long time, right? >> Well, I would say you need Q1. Really? >> Because supply gets so constrained from, well, even in a couple of weeks' time, right, mid-December. It's going to be very hard for you as to sell-off. >> So, even with the expiry, you think that there wouldn't be a major repositioning around this period of time, and then the auctions would pause, and then you'd have the drier position. >> But the question is who steps in, right? I mean, as long as everyone believes that it's hard for them to sell-off fine. But, cautiously bullish, but the industrials don't really have that- you could have a picture where industrial buying is just really weak. And so everyone looks at the fundamental balance, including what the industrials are doing. But if industrials don't buy, and the hedge funds have bored already and want to maybe just get out of their positions, and the utility that it really comes down to the utilities. But I'm actually standing here next to Stefan, and I'm asking the question, who's going to be the new money? And when will we see this new money come to the market? >> Because somebody needs to step in, right? I mean, unless hedge funds buy more- >> Right, the year end. They have this climate and everything, so maybe this would be the time for it, maybe the start of the year. But then there would be some exits at the year end, and then who's going to step in again. So that's- >> Yeah, I think that's a good point that obviously, the specs are going to have to exit at some point to realize their returns, right? >> And that's the key question. I think everyone wants to know. >> Yeah, but I think actually the answer is probably very simple, which is that it's industrials. Right? So it's something we watch- >> Something that we watch very closely, which I'm sure everyone does, is how commercial undertakings are kind of evolving week on week. And that's been sort of cautiously ticking up again. Right. >> And I think- >> But there's more utilities- >> But perhaps- >> Or maybe- >> Yes, we don't know, right? But I think particularly as the benchmark picture becomes more clear- >> Right. >> Now that you have the sort of draft numbers out, that is going to be- >> I don't know if you've got any clearer actually. >> [LAUGH] >> Well, I made everyone stop and- >> And actually- >> And actually- >> And focus on it again. >> Yeah, which is a nice supply side. >> But I think that's really going to be the kicker for a lot of industries to sort of- it'll make it clear to them. >> Okay, we are short now. >> It's going to make it clear to them, but then I still want that are they going to change the strategy based on that. What I'm hearing on the desk is there's a lot of- or not a lot, but there's quite some liquidity concerns again more than maybe six months ago. And to what extent are they really going to aggressively buy? That's what it comes down to. Because with the new benchmarks, okay, you have less free allocation, but who's really borrowing for their compliance? Meaning the majority isn't. And that means they have until 2027 to really realize it, right? So in their mind, they have a lot of time for that. So why have the urgency to buy aggressively at 90? I don't think that's something yet at least that they would do. They are really good, I think lately and also now from what we're seeing to buy the tips. >> Yes. >> And have been surprisingly well, I think when we sold off to 60 early this year, G-sky stepped in heavily at 70. So each one of the dips and a lot of them still want to just buy cheaper than the average, which makes sense. But I doubt that they're really going to be a price driver. They're more going to be the one that keeps us from falling too far. >> Yeah, I can see that happening as well. But it's going to be a bit of a slow burner, perhaps. >> Right. >> Which is maybe one of the reasons why Ball has been coming off so dramatically. >> Right. But to get back to the funds for a second, because I'm sure everyone asked that questions. At what point do we think different funds are going to take profit? I heard one guy, particularly a very big guy in the market who thinks at least 120 and he doesn't plan to take any profit anytime soon. I heard another one who rather said, well, he had a very good year and why. >> Keep holding on that until the end. >> Yeah, exactly. >> So actually, I noticed in my question, GDC, a behavioral ceiling around 85 years. Because this is where he potentially exits amongst hedge funds. >> I think we have to remember that the bulk of the builds happened at the 75-ish price. >> Yes. >> So everyone is kind of-- >> You can say it in the background. >> So they're not going to be selling anytime soon. >> Right. >> I think a number that we see thrown around is that magic, 100 number. >> Yeah. >> And I think-- >> But even we've struggled with that number in the past. >> Right, even then, as soon as we're at 90, isn't risk reward turning towards taking profit because 100 will be really hard to get through, maybe 95. You know, you probably want to take profit off at some point. I would rather maybe open a new long position if we sustainably broke through 100. No, I mean, I don't, I don't wildly disagree with that. I think going. Because you could have the situation where I think there was a rumor a couple of years ago when it was at 100, 100, 103 or something that then a big utility, German utility sold at the top. Right, so. Do you really want to, you know, not take any profit because that's also risk, no, if you're on the desk and you just didn't take any profit, you went from 75 to 100 and run spec to 80. That's not good for you either. There's definitely going to be some profit taking, I'd say, between the 90 and 100 levels. But a lot is going to. Yeah, how much, right? No, no, no, a lot is going to depend on sort of what's going on in the world at the time. You know, have we had a cold winter? Maybe power demand is picking up. Right. Maybe there's, you know, murmurs coming out of the EU, it has to review. Right. And that's what that could really drive. Right? If you have, especially a cold winter with little wind, that moves to spread upwards. Right? If we get the clean dark spreads and the lignite back in the money and fuel switching coming back or something, that would be interesting. But on the other hand, gas seems to be, maybe, no more about it than me, that it seems to be rather not just a slow burner, but rather on the bearish side, right? Gas is, yes, very, very bearish on the sort of medium-term. Do you think that there is some early move now on the gas market? Because we saw last week the position just going in the net short. So in how I see it, I feel that it's a bit premature to move in such a way. Maybe my thinking is simplistic around that, but like that the peace deal hasn't been concluded. And storage is. And storage is. It's quite low. Yeah, the return of Russian gas to you is not happening anytime soon. The storage, like that. Okay, but you have a lensee and all of that. I guess demand is pretty sweet. But then just counting and putting all your bets on the lngs also probably might create some choke point on the market and then also you're pricing in here a mild winter. So don't you see that it was a bit premature to move in this direction? I mean, you could say that gas has been a bit oversold in the last week or so. Definitely. But there's a lot of reasons for it. We've had a very mild winter so far. There's so much lng coming online over the next six months. A demand isn't increasing. And what the interesting thing is with gas running even ahead of lignite in the stack at the moment is making no difference. There's not enough gas we can burn to keep gas prices kind of elated, which has been really fascinating to watch. And we've actually. Yeah, we've not seen that before. We forecast. Long time or forever. Yeah, we forecast for the next couple of years. At the moment gas is taking up about a 60% share of the thermal stack. We have that going up to 65 and then 70% in future years. But even then you're not solving the gas balance. By the way, you're not solving the EUA balance either by that fuel switching element. Yeah, that's the other interesting thing. And maybe one of the reasons why when we sit set here last year, pretty much at exactly the same time when we discussed with Alessandro, he left the question to the next guest, which was, when are we going to decouple from gas? And we're there. And this seems like we're there. Like it's been. It's not even one year. Like it's been I think eight months or something. But it's almost like if I speak to our new younger colleagues, they're like, "Oh yeah, that's not. Is that even a. That's so outdated that almost that that doesn't happen anymore." But I'm thinking it makes sense to decouple because it's so cheap already. And fuel switches anyways in favor of gas. But if gas was bullish, I would, you know, very bullish for some reason. I would be pretty sure that there would be much higher hedging again, because power prices would be back in the money. And then we would have all the the lignite stack, etc. as well. So it's an asymmetry, right? That if you had a bet I guess on gas being bullish, that could work out really well for UAs as well. It really could. But is it realist? You know what's the chances of it? I mean, it's almost like everybody agrees on gas being bearish, which is usually the perfect time for being bullish, but on the same time like why? But what would be the shock actually that you're pricing for gas to be bullish? Whether, Mr. Mimbo factor by far, yeah. There could be some LNG issues here and there, but I don't think collectively, you know, there's, you're not going to have an idea. Yeah, when it has such an impact on gas, right? Especially January. But do you think the market is actually right in pricing in the return of the supplies to Europe? The return of the ocean supplies to Europe? Are they right? Or is it, or you mean the Qatar and all of those? No, just just just rise and like that the piece deal, or are they actually pricing in maybe the flows to China and the effect of the substitution effect in the. I mean, my take on the on that bearishness from the piece deal is more related to perhaps sort of less risk of, you know, attacks on infrastructure and stuff like that. And hence, you know, everything kind of comes off as a result. I don't actually think it's related directly to any flows. Because we don't really, I don't think anyone expects there to be flows from Russia. Yeah, exactly. I checked. Good to know. I checked on polymarket the prediction platform. I checked that again. I got to say I have a hobby of checking some stuff. But it's really interesting because you can see nobody really expects the piece deal this year. Even though it looks like, right? The negotiations are very close. So I would say if polymarket where you have only this one bed doesn't expect it, then you know, what's really about the gas traders that would. Let's shift gears a little bit and focus on carbon only. And there we have policy stuff. We've seen how policy came back actually earlier than expected. So already in autumn, we've seen headlines pop up, we did about Germany or then, you know, benchmarks. The reform is going to be published or the draft reform next summer only. But what are we going to see until then, right? What's your expectations of policy? Because back in the days, let's say the last reform policy was very bullish. What about now? Now, industry competitiveness, etc. seems to be much more of a topic. It just to just cut delayed. All of that. What's your take? I mean, I would say this is actually one of the key bear risks that were, you know, we're tracking very closely. I think, you know, the EU test review seems to me a little bit more kind of set in stone already. Like it's legislated. But I think all the other noise around it can increase, particularly if you start rallying. We're already seeing calls from Poland, you know, we want to keep free allocations. Right. The free allocation element, that's an important one. But then you have the MSR, right, that is probably going to be strengthened. Yes. To some extent, so isn't that maybe outwing because the market doesn't really care about anything post-2030, right? But then you have hidden pockets of supply actually within the balance that can bring supply in the market, whenever you add the clause. That's an interesting one. Just speaking about the flexible share, for example. A flexible share, and then you have the NER, and then you have something that comes from them, MSR, and then like with all of these elements, these are hidden pockets that are not triggered so far. And then they can easily come to the market. And that's hidden pockets, the politicians. I think they left them there for a purpose, right? If they need to tap into them, like they used to tap into for repower EU, they could tap into things. And different analysts have different expectations on this flexible share if it comes to the market. I think if I'm not mistaken, the market few is that it does not necessarily come to the market, at least not the. There isn't a trigger. Now within the directive that basically it comes to the market on the specific circumstances. So I'd say that they need to change the law for it to happen. Right. Which they could easily, right? If they stuck with the Poland and now also, I guess, other countries that want to protect their industry much more. Because you want to bring more. And that's a headline risk. When is such a headline risk doing popping up? Because I would argue it shouldn't really pop up in a way that it scares the market before the reform proposal is out, right? These things usually come late in the stage when they cannot find a agreement between parliament and a council or something, then one of those things. Or sometimes in the parliament, when the parliament comes out with crazy things like, "Oh, let's keep hedge funds out of the market." But I would say they should come late, right? The risk of it happening before the summer is what? Three percent? We have so much noise anyways about how individuals want to maintain their free allocation and the CC. That is true. That is true. That is much higher. It's gaining traction in major countries like Avjorni and France that are holding most of the industrial production and Poland as well. So they are calling for this. So I do agree with the virus. That is true. That could almost be what we see now, right? So Germany, for example, is positioning themselves now with their proposal before the commission proposal comes up. That's the interesting one. So maybe it's more than 3 percent at risk. I think though the free allocation point, you know, as headline grabbing as it is, I think it's a little bit of a mute point because it's not going to, like, you still have the cap, right? So if there's more free allocation, there will just be less auctions. It will always be balanced to a certain extent. Yeah. It does, but it really depends. I think this whole whoever was closing the market has followed, you know, the benchmarks coming out and different service providers coming with different numbers. But I would argue we still don't know how free allocation is really going to look like because you have so many elements that go into it. You have not just the benchmarks, which are not final. You also have the rebasing of activity levels, which fire reinstellation is different. Nobody really knows activity levels, so you have to make assumptions. So you can go wrong there. There's indirect cost staff, there's specific rules for Polish, free allocation. So there is a lot of elements still, I think what we know is that the drop will be substantial, but at the same time you need that drop really for a very strong bull story. If you didn't have that, then we might almost be in a slightly Polish environment, but not a lot of it. So the bull story hinges upon free allocation to be cut strongly. 4, 22, 26, yes indeed. But since we're running out of time, I just wanted to ask two questions actually. So the first question is about what is the policy event that you're looking at and you're pricing in for next year and you're like, well, that's it. That's the one thing that's going to make the market. I know that you mentioned free allocation. And then the second one, what is the policy that you think the market is too one-sided about it? I think the one event, we're always banging on about this in the office, about the review next summer. I think with the 2014 negotiations having thrown in a few curveballs, I still felt like in the end, the core message of Europe's climate policy wasn't touched. So I feel like the EU test reviewed, to some extent, is I don't think it's going to risk the integrity of the UTS. I think it's really clear that we need higher carbon pricing in order to send the E-carb signal to sectors other than the power sector. So that's really, I mean, it's not so much a key event, I suppose. It's like eating up to the summer. But still, it's interesting. It's kind of the frame, right? It helps us understand which regime we're in and which and back in the days, a couple of years ago, everybody was trying to outpace themselves with the ambition. And now there's not the case anymore, right? So now you have much more balanced, almost outline. My former boss said, well, maybe that's actually a healthier negotiation standpoint than just trying to be more and more ambitious. What was the second question? So the second question was, like, which event do you think the market is too one-sided? Yeah, almost like what's priced in but where the market might just, everyone has the same few basically, bullish. Just wait till all those specs. We'll be looking at our wounds. It's a tough one because you have clear fundamentals. And then if you're trying to be too smart, you can also just lose out. Right? The market can appear like, oh, yeah, you maybe have made a mistake and then you get weak and you get out of your position, but actually you should just chill. Yeah, we were talking about this as I arrived late here today in the studio. But yeah, I've changed my trading style quite a bit over the years. Nowadays I have a core view and trade once a week maybe. Yeah. One last thing from my side, actually, I wanted to ask you, how do you trade the noise? Do you trade the noise at all, actually? Yeah, a good one. Sometimes I trade the noise. I want to hear the story of COVID. Oh, yeah, I guess it was a bit of a noise. Yeah, so this was back in March 2020, I guess it was. Right. And at this time, I was saying this was one of the best trades I've ever had when puts were really valuing that they were getting cheaper versus calls because banks were selling the structure to their customers. And I was saying there as a very, very active option strainer thinking, "Hmm, someone is selling me like puts for free effectively." So I filled my coffers with puts right at the end. It was literally two weeks before we had the big crash. Right. So like mid-March or something. Yeah. So basically had. Yeah, and it was interesting because carbon didn't, at first, carbon didn't move. Right. When equity sold off and everyone was like, "Oh, yeah, carbon is a different asset. It's decorrelated." Yeah. And they are actually, well, then actually both Vega and Delta kind of moved my favorite, which was very nice. But I think. But you had a couple of things back then, right? So you had this policy news that compliance is delayed, which didn't happen in the end. But that happened. Right. So you had the policy, you had the general market selling off. And then I guess some of it was stronger because of the options, right? Yeah. And then actually the interesting thing was we actually stopped at 16 euros, which is what, you know, a big fuel switching level at the time. Right. And it'll be interesting what kind of levels like that we have in the future. Maybe on the industrial switching side on the upside. And I remember all the analysts, including myself at that point, thought that we keep going because we all have this inside bias. You know, wherever it's been going lately, that's kind of the linear progression of that. So I wonder if right now, maybe as a last point, we've been kind of slowly grinding up and everyone expects a slow grind up, right? Well, utility is really low. Are we going to finally see some bigger moves maybe on that? What's your take? I'm afraid to give a disappointing answer. But I don't think there's going to be any big moves to involve, unfortunately. Unless there's, you know, something crazy happens. We'll take this to next year, the low wall system. I'm afraid so. Okay. Yeah. Which suits my trading style perfectly. I can just sit back and relax. Something always happens, something crazy, especially when you don't expect it. So Julia, last time we had a question from our guest who said that, do you see whether derivatives finally taking off is there demand for that time of hedging from carbon or power traders? I think there should be demand for it. There should be. We discussed it last time. They make so much sense for it to be. Yeah. I don't know why they haven't taken off. They must just simply be too expensive. It is impossible to forecast the weather in three days' time. Why would someone trade? Always just trading desks, not allocating any risk capital to metrologists. We actually did at Gasprom. We had Mets actually able to trade. You can trade in a polymarket now. You can trade the weather. No, you do in your spare time. I'm always geeking out on some random stuff. Without real life, well, that's a nice one. But anyways, so you think there should be, but. Yeah, I just. I don't know. I'm not going to hold my breath. Then let's. So the audience can, by the way, also leave questions. We're going to try to answer in our next episode. Please feel free to do so. And be one of the lucky ones that get taken for it. Julia, you also have the opportunity now to leave a question for the next guest without knowing who it is. Yeah, that's the tough one. Not knowing who I'm asking the question, too. Yeah, so my question is about the EUTS review this coming year. What do they think a possible curve ball is going to be? Or is he surprised in the review? In the review. Yeah, because I'm very excited about the review. So I'm curious for everyone else thinks about it. Right. Yeah, it's going to be one of really the key topics, I guess, as we go into next year. Julia, Riham, thank you so much for being here. It was a pleasure discussing. Let's see how the winter turns out, especially. And for the audience, thank you very much. It was another great year and see you next year.