European Carbon Allowances Flirt With €100 Threshold; KEUA Invests

Regulatory tightening could see European carbon allowances prices begin to rise in the mid to long term as the bullish investment case grows for carbon allowances globally. Already EU Allowances (EUAs) are hovering near the €100 mark, riding out the short-term uncertainty of regulatory changes that could temporarily depress prices but create long-term price pressures, creating a strong investment opportunity.

European Parliament approved the REPowerEU initiative last week, the bill that will be responsible for funding the EU’s move away from reliance on Russian fossil fuels. The legislation will fund this transition by pulling allowances forward from future auctions between 2027-2030 in a frontloading decision that will fund about 40% of the €20 billion budget needed for the energy transition.

“Long-term, frontloading allowances will lead to a tighter supply in the market than originally planned for the years 2027-2030, potentially boosting EUA prices toward the end of the decade. However, in the short term, adding roughly 60 million EUAs to the annual supply between 2023 and 2026 might depress EUA prices,” explained Luke Oliver, managing director, head of climate investments and head of strategy at KraneShares, in the Climate Market Now blog.

“That said, we think the market has already factored in most of this extra supply.”

The Long-Term Bull Case for European Carbon Allowances

The December 2023 futures contracts crossed the €100 threshold briefly in trading on Tuesday before retreating to €96 again on Wednesday after hitting six-month highs of €97 last week.

Image source: ICE

The recent rally is one that Oliver suspects is less news-oriented and more based on technicals. EUAs typically experience a rise in prices in the first quarter as industrial participants finalize the previous year’s annual compliance cycle and surrender the EUAs that accounts for the previous year’s emissions. The REPowerEU changes, which will be voted on a final time in April by the EU Commission, have meant a delay to the distribution of free allowances allotted each year for participants.

“Often these entities ‘borrow’ their new allowance issuance to pay for the previous year’s compliance obligation. However, these delays mean that more industrials will likely be forced to buy EUAs to meet their requirement, which has historically pushed prices higher in the first quarter,” Oliver explained.

The KraneShares European Carbon Allowance ETF (KEUA) offers targeted exposure to the EU carbon allowances market and is actively managed.

The fund’s benchmark is the IHS Markit Carbon EUA Index, an index that tracks the most-traded EUA futures contracts, a market that is the oldest and most liquid for carbon allowances. The market currently offers coverage for roughly 40% of all emissions from the EU, including 27 member states and Norway, Iceland, and Liechtenstein. KEUA has an expense ratio of 0.78%.

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