One of the biggest stories in European energy markets last year was the 200% jump in EU carbon allowances (EUAs), with prices rising from around €8/tonne to a peak of more than €25/tonne.

The impact of the 2018 carbon surge on power plant generation economics was profound, pushing margins for many coal-burning plants into negative territory and ushering in a widespread switch to natural-gas fired generation.

But EUAs have stabilised since the start of 2019, and the continuing decline in coal generation is now more attributable to a months-long slump in natural gas prices.

The first chart shows an index of power, gas, coal and carbon prices dating back to Jan. 2, 2018.

European Front- Month Energy Price Index 2018-2019

European Front- Month Energy Price Index 2018-2019

Carbon’s rally in 2018 reflected the approval by the European Union of a mechanism to remove a surplus of EUAs that reached as much as 1.6 billion tonnes. The glut of allowances was blamed on over-generous allocations dating back to 2008 as well as the use of cheaper United Nations carbon offsets for compliance with the EU carbon market rules.

Last year’s 200% price rise helped boost power prices, which in turn dragged up values for gas and coal. The gains in fuel and power prices also reflected some fuel stockpiling by utilities and other users around the world ahead of the winter 2018 season.

Since the turn of the year, however, power, coal and gas prices have all shifted into reverse even as carbon prices have maintained their gains. A mild winter in 2018-19 left gas storages and coal stocks at high levels around the world, damping demand and prices.

This has been particularly true for natural gas. The overstocking for winter 2018 coincided with the start-up of new liquefaction capacity in Asia and the United States, and a sharp rise in exports of LNG have acted as a depressant on the market ever since. Prices at the Dutch Title Transfer Facility have dropped by more than 50% in 2019.

Coal prices have also tumbled on the back of falling demand in Europe, combined with restrictions on imports into China. The benchmark API2 month-ahead price is down by about 42% so far this year.

But burning coal for power emits roughly twice as much carbon dioxide as natural gas, and coal prices haven’t fallen far enough to keep the fuel competitive for power stations.

Chart 2 shows the clean dark spread (operating margin for coal plants) and the clean spark spread (margin for gas plants) on a month-ahead basis in Germany since the start of 2018.

Rolling Front- Month German Clean Dark, Clean Spark Spreads

Rolling Front- Month German Clean Dark, Clean Spark Spreads

Since the end of January, gas-fired power has become considerably more profitable than coal, and this has led to wholesale switching of power plants from coal to gas.

Whether this shift to gas continues will depend on the evolution of forward prices. At present, calendar 2020 prices show gas- and coal-fired plants earning €1 to €2/MWh respectively (Chart 3). This narrow advantage may not be enough for persuade utilities to commit to burning coal next year.

Year- Ahead German Clean Dark, Spark Spreads

Year- Ahead German Clean Dark, Spark Spreads

Analysts are already trying to predict where gas prices will go in 2020, and many of them say there isn’t likely to be a strong tightening of supply in the coming months, unless there is a resumption of the dispute between Russia and Ukraine over transshipment of the fuel.

As a result, analysts say, forward gas prices may decline as next year approaches, putting gas-fired power firmly in the drivers’ seat for longer.

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