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be a little on the low side, winter season contracts are even higher, which should be a signal to increase forward hedging levels – unless the utilities still believe additional upside is likely. The recent increases in spreads seem to reflect:

• The growing concern that the shutdown of 8.3 GW of nuclear

capacity in Germany means that winter peak demand could be difficult to meet with existing capacity if renewables are unavailable (cold, cloudy, still days).

• The lack of hedging this year, and with the demand side (ie, retail

power suppliers) now seemingly coming more into the market, the hesitancy on German generators to hedge is starting to increase the premium offered to them. With increasing spreads across the curve having been a trend, this probably suggests a structural lack of sellers in the market. It could also mean that some capacity is not being hedged on the expectation that it will be closed shortly.

One of the biggest market disappointments we have explored is the lack of any acceleration in hedging volumes by utilities. Over H1 2011, traded volumes were down 13% YoY, and the increase in open interest across all contracts was down 10%. In the first weeks of H2 2011, this picture has started to change with good YoY increases registered in traded volumes (now flat YoY for YTD volumes) and in increasing open interest. Thus, there is evidence that the better spreads are already encouraging better hedging levels by the generators. We have noted that the 2013

spreads have started to narrow, having retreated from about €9/ MWh to dip below €7/MWh, which would be consistent with the evidence that greater volumes of trade are being seen post-2012. With hedging being sensitive to offered spreads, and spreads being sensitive to hedging, it remains a tough call as to whether the higher levels of

70 September 2011

hedging recently will continue. The competing factors here are:

• There is certainly an incentive to start to close older capacity once the last free allocation of EUAs to generation happens in February 2012. While it is unlikely to be immediate, it could certainly happen throughout next year, which would help increase spreads by tightening capacity levels.

• The pace of new build continues, with our renewable equity analysts forecasting that Germany will add 20 GW of solar

and 10 GW of wind in the period, while most of the under- construction 10 GW coal-fired capacity that has been facing delays should come online in the same period. The cumulative effect would be that spreads for the second half of 2013 and 2014 would be expected to come-off from current levels.

While these are competing factors, the fact that so much of the

new capacity is renewable might lead to system operators wanting to keep some of the older capacity online as standing reserve. While this would mean payments to the generators, it would keep the pressure on spreads. The conclusion is that spreads, even about €7/MWh for 2013, might be seen as good compared to what might be on offer once this capacity starts being commissioned. So, we do expect some better forward hedging for the remainder of the year.

Early Volumes – Bearish Again The upwards price pressure of greater hedging this year may

still be dampened somewhat by the sales of phase 3 EUAs in the market by the EIB. The EIB will start sales of the 300 Mt sell within one month of receiving them from the EC. The EC will be able to transfer these to the EIB towards the end of September. The question, though, remains will they? The options for the EC are:

• To transfer at the first opportunity. A reason for doing this is that the EIB has committed to sell all of the NER 300 into the

market by the end of 2012, and an early transfer gives it the longest available time window to spread out the sales. It also suggests that the EC would not take an active position on price development in the secondary market. Even if the transfer is made in September, the 2011 time window for sales will be limited and would suggest that 30-40 Mt would be brought into the market.

• To wait and effect the transfer until Q1 2012. While this would condense the sales window, meaning greater weekly volumes

would need to be sold, it could help align the sales with even stronger buying by the utilities and possibly mean better price support. Such behaviour would reflect an increasing level of view taking on prices by the EC, a role that might not be comfortable. Having said that, the EC’s registry regulation did include in its preamble the rationale for not selling any of the 120 Mt of phase 3 EUAs precisely to minimise the effect of the sales on the secondary market.

While our base case assumption is that 30 Mt of phase 3 EUAs

will be sold by the EIB in Q4 2011, there remains uncertainty regarding these numbers. Looking ahead to 2012, the core uncertainties remain the

same: economic performance; utility hedging; and will all 420 Mt of phase 3 EUAs ear-marked for sales by the end of 2012 occur. Adding to this uncertainty is how much of the phase 2 New

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