EU ETS Could Rally on Improving Macroeconomic Factors

The European Union Emissions Trading Scheme (EU ETS) saw challenges in November, but macroeconomic factors could help the market recover.

Front-year contract prices fell by over 10% in November, according to KraneShares, driven by short selling due to a gloomy macroeconomic outlook. Additionally, a 20% drop in European fossil fuel generation weights on front-year contract prices.

Looking ahead, macroeconomic factors could be potential catalysts for recovery. These factors include the expected interest rate decreases, short positions potentially being covered, and profit banking, all of which may positively influence prices, according to KraneShares.

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Exposure to the European Union Emissions Trading Scheme (EU ETS)

The KraneShares European Carbon Allowance ETF (KEUA) offers targeted exposure to the EU cap-and-trade carbon allowance program. EU allowances (EUA) are carbon credits used in the EU ETS. Notably, prices of EUAs more than tripled between 2019 and 2022.

The KraneShares European carbon allowance ETF is benchmarked to the IHS Markit Carbon EUA Index. The index tracks the most traded EUA futures contracts. It has returned an impressive 35.4% annualized from August 2014 through July 2023.

The impressive performance of KEUA’s underlying index does not come without heightened volatility, however.

Compared to California Carbon Allowances (CCAs), EUAs realized three times higher volatility of 43% with a worst 12-month return of negative 47%. CCAs, in comparison, realized more tolerable volatility of 14%, with a worst 12-month return of negative 19%, according to Oktay Kurbanov, Partner at Climate Finance Partners (CLIFI).

To combat this volatility, investors can add balanced exposure to both EUAs and CCAs. CCAs are investible through the IHS Markit Carbon CCA Index, tracked by the KraneShares California Carbon Allowance ETF (KCCA).

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