Looking for an Inflation Hedge? Consider the Carbon Markets | ETF Trends

Market volatility continues as investors absorb and respond to concerns around inflation, war in Ukraine, rising interest rates, and other factors. Advisors and investors have increasingly sought refuge in safe haven assets, and commodities have seen a spike of inflows not experienced in years. When considering commodities as a hedge for inflation, advisors should look to carbon markets as a good short- and long-term opportunity.

Carbon markets and carbon allowances have a key role to play in the global transition to net-zero emissions. European carbon markets are feeling the immediate impacts of the geopolitical conflict happening between Russia and Ukraine, and Luke Oliver, managing director and head of strategy for KraneShares, explained the link between European carbon markets and Russian oil and natural gas.

“Simply put, as Russian gas supply exacerbates natural gas prices further, industries, notably power generation, will need to burn more coal. More coal means more emissions, which mean more demand for carbon,” wrote Oliver in a communication to ETF Trends. “Shifting to coal or oil, from expensive natural gas also increases their prices. In this environment it is not surprising to see the complex rising together.”

The invasion of Ukraine by Russia and the lasting impact of potential movement away from Russian oil and natural gas permanently for Europe has introduced a lot of uncertainty into the market, resulting in volatility and a technical sell-off. The sell-off in European Union Allowances (EUA) has provided investors an opportunity to gain access to the market at attractive prices.

“Short term, there is potentially opportunity to enter the carbon markets after a technical sell off and uncertainty around fundamentals. As the Europe Union has affirmed its tightening measures of the market we have seen confidence increase to re-enter,” Oliver explained. “Long term carbon should outperform oil, coal and gas as it essentially ushers the demise of these fossil fuels over time.”

Seizing the Price Opportunity in European Carbon Allowances

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, which come from the oldest and most liquid market 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. The annual cap reduction was recently increased from 2.2% to 4.2% to meet long-term carbon emission targets.

As the fund is actively managed, it may invest in carbon credit futures with different maturity dates or weight futures differently from the index. The fund potentially trades in CTFC-regulated futures and swaps above the CFTC 4.5 limit and is therefore considered a “commodity pool.”

KEUA has an expense ratio of 0.79%.

For more news, information, and strategy, visit the Climate Insights Channel.