London (Platts)--12May2008

The fundamental price driver for the German forward curve, especially
year-ahead, over the past year has shifted away from emissions to coal,
according to a survey of traders and analysts by Platts.

While during the first half of 2007 the German power market was talking
of a correlation between year-ahead power and European Union Allowance carbon
prices (under the EU Emission Trading Scheme), traders' focus gradually has
been shifting to coal as the main price driver for German forward power.

One reason for this shift was coal being much cheaper during the first
half of 2007, "but when coal prices started to shoot up we were forced to
increasingly look at coal as a price driver," one trader with a major German
utility said.

The price for year-ahead API2 coal almost doubled from $75/mt in May 2007
to $146/mt on May 9 this year, according to Platts data.

Another utility trader said that CO2 was overvalued as a driver at first
because it was a new product. "In 2006-07 everybody was looking at the new
kid in town [CO2] so we all followed it around and before we knew it, the tail
started wagging the dog," he said.

A German carbon trader said carbon prices themselves have also been
gradually detaching themselves from German power as "CO2 now reacts mostly to
fuel switches between coal and gas."

Beyond rising prices, market players also attribute the globalization of
coal to its renewed significance for power pricing. Developing economies such
as China and India, both of which possess healthy domestic coal reserves, have
nonetheless had to steadily ramp up coal imports to satisfy their growing
energy demand. Meanwhile power shortages in South Africa and China earlier
this year have placed question marks over those countries' coal export
performance for 2008, while a string of force majeure declarations in the
Pacific region after major floods in Queensland, Australia placed the global
coal supply chain under even greater pressure.

"Until early last year coal traders were highly Eurocentric," said one
market source and added that rising freight costs and dependence on coal
imports from key producers such as Australia and South Africa had globalized
the European coal markets.

According to the source, many trading companies therefore had to
re-assess their coal procurements, hire specialist coal traders and since have
become much more savvy in trading activity. "All this," he added, "is a result
of rising prices and globalization of coal."

Coal, power and carbon price developments since the beginning of May give
an indication of the switch from a carbon/power to a coal/power correlation.
On May 1, German Cal 09 baseload power closed at Eur65.25/MWh, according
to Platts data. By May 6 year-ahead base broke through Eur68/MWh for the first
time ever and by May 9 Cal 09 base traded beyond Eur69/MWh.

While EUA December 2008 carbon prices also rose between May 1 and 6 from
Eur23.63/mt to Eur25.33/mt, the contract then dropped back below Eur25/mt
on May 8 closing around Eur25.15/mt on May 9.

"The reason for these movements had nothing to do with power prices," one
emissions trader said and added that EUA price swings during this time were
down to swaps between EUAs and CERs--Certified Emission Reduction units under
the Kyoto scheme.

Coal, however, rose from $143.25/mt to $151.25/mt for the API2 Q4 08
contract during the same period, pointing towards a correlation between coal
and German power, traders said.

Some players also point to oil prices as an essential power price driver
but most agree that the reasons are different ones. "Oil prices are a general
sentiment for the global economy," said one financial trader and added: "When,
as is the case now, oil prices surge that is more of a macroeconomic indicator
especially for the United States and we all know that when the US sneezes the
world gets a cold."

In other words, he said, it is not that oil and German power are
correlated but rather that the German economy as a whole is in correlation
with the world and US economies.

A direct coal/power correlation, however, made more sense, sources said,
as power generation in Germany and coal prices are directly linked.

Over 40% of German electricity is generated from coal, making it by far
the most important fossil fuel for power generation before natural gas at
around 10%. Nuclear power generates around one third of German power and
renewables close to 15%.

German coal mining is in decline, with its last remaining hard coal mines
set to close by 2018, when subsidies dry up. This means that the country's
generating utilities rely heavily on global coal imports and sharply rising
prices of the fuel have "naturally pushed power back into correlation with
coal, just as it was before emissions trading started," one source said.

A strong indicator for a coal/power correlation, according to one source,
is looking at the dark spread--the margin on sales of power generated by
coal-fired plants. "The dark spread in Germany is much more important than any
other [such as spark spreads, for electricity generated by gas, or clean
spreads, including CO2 allowances] which is obvious given the amount of
coal-fired generation in Germany," he said.

Coal prices are in backwardation, with the German energy bourse EEX
quoting ARA coal futures Cal 09 at $144.12/mt and ARA Cal 14 at $130/mt. The
same power contracts, by contrast, are in contango with EEX Cal 09 base at
Eur68.75/MWh and Cal 14 base at Eur73.75/MWh.

"This makes it very interesting for generating utilities to hedge power
as far out as possible and buy coal," one utility trader said.

"Basically, all that's happened between power and coal/emissions is that
the dog is wagging its tail again and not the other way round," he added.
--Henning Gloystein, henning_gloystein@platts.com
--Gareth Carpenter, gareth_carpenter@platts.com