Volatility seems to have been the defining word for markets in the first quarter in 2021 and continues to be seen across industries and sectors. One industry in particular that has experienced volatility driven strongly by geopolitical risks and its impacts to the energy sector has been the carbon allowance markets, specifically in the European Union.

European Union Allowances (EUAs) were up 9% in trading yesterday, finally breaking above the €80 resistance level after a protracted time of sideways trading while many participants sat on the sidelines, waiting to see which way the volatility would resolve, explains KraneShares in a recent post on its Climate Market Now blog.

The move is attributed to a variety of potential catalysts, including the April 30th compliance deadline, which historically has caused a short squeeze in the markets as compliance entities rush to ensure that all their obligations are covered. This type of sharp price movement was expected to be alleviated somewhat by the free allowance distributions that were allocated for 2023.

“Given the scale of these markets and the way in which many participants access them, we tend to see more technical momentum on larger moves than asset classes such as equities. This is part of the reason we have historically seen higher volatility in carbon allowance markets,” KraneShares writes.

Another potential catalyst was a vote in Europe yesterday by the industry group ITRE (Institute for Transportation Research and Education) to consider limiting the involvement of speculative participants. While not a definitive vote that alters anything for now, it will be taken into consideration by the European Commission. For reference, an ITRE vote that went on to be applied was the support of the Fit for 55 Tightening, which seeks a 55% reduction in greenhouse gases by 2030 in Europe and ramps up targets to help achieve that goal.

While the jump yesterday is a noteworthy one, given the volatile nature of carbon allowance markets, it’s better to focus on longer time horizons, according to KraneShares.

“For investors, this may be a case to watch longer-term moves and focus less on single-day moves,” advises KraneShares.

How to Invest in the EU Carbon Allowances Market

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, which tracks the most-traded EUA futures contracts, 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.