The price of emission credits on the EU’s Emissions Trading Scheme (ETS) increased six-fold in the two years to mid-2019 reaching €30 per tonne. Over the following 18 months the price has typically traded between €23 and €30 per tonne, except for a brief drop to €16 per tonne during the March 2020 liquidity crisis. Since then the price of carbon has knocked on the €30 per tonne ceiling twice more before breaking through that resistance decisively during December. Over the past two months carbon prices have surged by one-quarter to around €38 per tonne.
We’ve talked before about the risks behind investing in political markets. Remember that a carbon credit is not a real, deliverable commodity. It is a legal construct that will continue to exist only for as long as governments want it to. If they lose interest in capping emissions, or stop co-operating to do so, the market will collapse. As the 2018 gilets jaunes protests in France demonstrate, governments can buckle under the weight of public protests, especially if industries and jobs are on the line.
With those caveats in mind, the question for investors then is how to profit from higher carbon prices, and what are the other reasons they might want to.
One way for investors to play the trend is the new KFA Global Carbon exchange-traded fund (KRBN), which tracks the performance of carbon credits. It began trading in July 2020 and is up 40%. It’s bench marked to IHS Markit’s Global Carbon Index, which tracks the three most widely traded carbon credit futures contracts.
Another more speculative way is via the voluntary credit market. Here though the risks are significantly higher, not least because of the possibility of emission reductions being double counted in this largely unregulated market. In December 2020, digital asset marketplace, Uphold launched the world’s first tradable carbon token on a public blockchain. Each UPCO2 Token represents one year-ton of CO2 pollution averted by a certified REDD+ project preventing rainforest loss or degradation. The price of carbon on the voluntary market trades at a significant discount versus the regulated market – at the time of writing 75%.
Overall though, gaining an exposure to the potential carbon price upside could be useful for an investor wishing to hedge against the costs of her portfolio of companies transitioning towards decarbonisation. For example, energy and mining sectors in particular, as well as countries such as Canada and Australia companies are likely to face large transition costs under a carbon constrained future, especially one in which the price of carbon is very high.