Gas still key for European fuel-switching despite growing carbon influence

Additonal reporting by Florian Rothenberg

LONDON (ICIS)–Carbon is in line to exert greater influence over the wider energy complex in September as EU political debates resume, but gas will remain at the forefront of European fuel-switching dynamics.

As the political process takes off following the peak holiday season in August, ICIS Analytics expect carbon market dynamics to shift back to a balance between policy- and gas market-driven moves as market participants monitor the political process closely.

While bullish sentiment may build in the carbon market, it is unlikely to usurp gas as the leading driver of fuel-switching dynamics in the near term.

Coal-to-gas switching incentives across Europe were eroded further in August as regional gas prices continued to test new highs, paving the way for multi-year highs for coal and lignite production.

However, any carbon upside emerging from the political debate is unlikely to significantly improve coal-to-gas switching incentives in the near term in countries such as Germany with this trend likely to remain throughout the rest of 2021 , because gas is trading at prohibitively high levels.

FURTHER CARBON-GAS DECOUPLING LIKELY

High carbon price volatility may be reignited this month with the start of the legislative process for the EU’s “Fit for 55” package, which puts the ambitious EU ETS revision plans of the European Commission under scrutiny by lawmakers in the European Parliament and Council.

Proposals include widening the scope of the EU ETS, and adoption of the package could lead to a further rise in carbon prices in the long term.

The upcoming weeks will give an early indication of the direction the package might take with some member states like Poland or Spain already indicating resistance against high end-consumer prices.

Signs of a potential watering down of the proposals or strengthening of non-market measures (e.g. increased renewable targets) and subsidies could lead to an immediate bearish reaction.

At the same time there are elements in the package that present a potential upside risk such as an even stronger allowance supply cut than suggested by the commission.

GAS CONCERNS REMAIN

While the carbon bulls may reconvene, the gas market is already locked in a bullish trend with high prices threatening the competitiveness of gas-fired electricity generation and undermining coal-to-gas fuel switching.

Low natural gas stocks have left European gas hub prices vulnerable to high upward pressure should further supply concerns materialise.

Sites were 64% full at the end of August, remaining at all-time lows but gaining 12 percentage points throughout the month. In July, stocks only rose by 10 percentage points.

However, uncertainty clouds gas pipeline flows into Europe, an ongoing threat to supply margins.

Russian gas flows have been volatile in recent weeks amid upstream issues in early August, while Norwegian gas infrastructure has suffered from unplanned outages in the middle of the maintenance season.

Planned maintenance at the Troll, Oseberg, Gullfaks and Kollsnes facilities started on 2 September, causing capacity offline to increase to almost 70mcm/day from 43mcm/day on the day before, data from offshore operator Gassco showed. Daily capacity cuts will trend upwards to 126mcm/day on 14 September.

Elsewhere, LNG flows into Europe have already been suppressed this year with Asia and South America providing fierce competition in the global market. The market is expected to remain tight this year.

Another looming threat is the ongoing hurricane season in the US, with above-average activity forecast which could disrupt supplies into Europe in the coming months. The expectation of hurricane-related damage to US export facilities ahead of each storm will be a bullish driver for Henry Hub prices, and other gas markets, even if widespread destruction does not materialise.

FUEL SWITCHING INCENTIVES SLASHED

Coal-to-gas switching incentives are only expected to increase should gas significantly retreat below the fuel-switching gas price limit , but latest price trends and fundamental data suggest further price upside.

The German front-month fuel-switching costs, the theoretical EUA price required to trigger a switch from coal to gas, averaged €81.14/MWh in August for average coal and gas plant efficiencies. This marked a monthly jump of 43% and is the highest monthly figure ever, according to data going back to 2015.

In August last year, the German front-month fuel-switching cost was -€4.85/MWh. A negative number means the fuel cost alone was enough to incentivise the switch.

In contrast, the EUA benchmark price averaged €56.46/tCO2e in August, its highest monthly figure ever.

August levels were 6% stronger month on month and more than double year on year but languish below the front-year fuel-switching incentive for the second month in a row.

German coal and lignite accounted for an 82% share of the country’s total thermal generation, its highest share since May 2019.

It was the greatest August share since 2018, the year when European gas markets last faced significant supply tightness amid low natural gas stocks.

Gas was responsible for the remaining 18%, its lowest value in nearly three years.

ICIS Analytics subscribers can find daily power generation and emissions data here and fuel-switching here .