Carbon markets in California are potentially positioning to drive allowance prices higher in the coming months and years as the Air Resource Board works to wrap up its latest five-year update to the state’s climate strategy. Luke Oliver, managing director, head of climate investments, and head of strategy at KraneShares, broke down recent activity in the California Carbon Allowances markets and provided a second-half outlook for the shared California and Quebec market in a paper.
The ARB is working through its final revisions of the updated 2022 Scoping Plan that creates the framework and outlines the path forward to meet the 40% reduction of carbon emissions (compared to 1990 levels) by 2030, and reaching carbon neutrality by 2045, five years ahead of the national goal.
The Scoping Plan is under pressure from California’s Governor Gavin Newsom (D) to tighten measures and create greater pressure on industries and build out alternative energy options.
“Some of the new actions Newsom outlined include enhanced efforts to advance offshore wind, a more stringent Low Carbon Fuel Standard (LCFS), a new aviation clean fuels target, residential heat pumps target, new natural and engineered carbon removal goals, and addressing methane leaks,” explained Oliver.
Alongside the infrastructure law passed in November 2021 and the Inflation Reduction Act signed into law on August 16, it will provide regulatory support for the space and create upward price pressures as measures tighten. A reduction in allowances available will help provide pressure on industries to alter their emissions practices, driving cleaner operations while the cost of available allowances rises from a shorter supply.
CCAs have declined over the summer in a movement that is attributed to the macro environment of high gas prices and inflation.
“Looking ahead, analysts and market participants largely anticipate strong upside potential for CCA prices as buyers may take advantage of the weakness in price,” Oliver wrote. “Moreover, between Newsom’s comments, the Inflation Reduction Act, and the infrastructure bill there is a clear directional path and appetite for increased climate regulation, creating an environment that can be bullish for CCA.”
Investing in California’s Carbon Market
The KraneShares California Carbon Allowance ETF (KCCA) offers targeted exposure to the joint California and Quebec carbon allowance markets.
“Investors have been increasingly positioning in California allowances, with KCCA shares outstanding increasing by 60% since May, 95% YTD, as many speculate that the program offers improved risk-return relative to the larger, higher price schemes,” Oliver said.
KCCA is a fund that offers exposure to the California cap-and-trade carbon allowance program, one of the fastest-growing carbon allowance programs worldwide, and is benchmarked to the IHS Markit Carbon CCA Index. The CCA includes up to 15% of the cap-and-trade credits from Quebec’s market.
The index measures a portfolio of futures contracts on carbon credits issued by the CCA and only includes futures with a maturity in December in the next year or two while using a wholly-owned subsidiary in the Cayman Islands to prevent investors from needing a K-1 for tax purposes.
The fund may also invest in emission allowances issued under another cap-and-trade system, futures contracts that aren’t carbon credit futures, options on futures contracts, swap contracts and other investment companies, and notes that aren’t necessarily exchange traded.
KCCA carries an expense ratio of 0.79%.
The KraneShares Global Carbon Strategy ETF (KRBN) also offers exposure to California’s market with 30% of the fund allocated to CCAs as well as carbon allowances futures globally from the EU, RGGI, and the U.K. and has an expense ratio of 0.78%.
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