Advisors and investors are no strangers to market volatility as inflation and interest rates climbed in the last two years. While volatility creates challenges for some investors and their portfolios, for others it proves a boon, driving price discovery for assets.
Several asset classes inherently generate more pronounced volatility than broad equity benchmarks. Nascent and speculative asset classes as well as assets like commodities all carry an elevated volatility profile. Within commodities, this is particularly true for carbon allowances, the unit of trade within regulated carbon markets.
One carbon allowance equates to one metric ton of carbon dioxide emissions. Each market has a cap on allowed emissions and a trajectory that tightens over time to reduce harmful emissions.
Similar to other commodities, carbon allowance prices experience periods of enhanced volatility. This can occur after new regulatory announcements regarding supply changes, or because of technical trading. In both Europe and California, carbon market volatility remains elevated this year.
Volatility and the Path to Price Discovery
“Volatility is appearing in the carbon markets again, and I see that as an opportunity,” explained Luke Oliver, managing director, and head of climate investments at KraneShares.
The periods of elevated carbon allowance price volatility this year are linked to increased investor activity, explained Oliver. The California carbon market saw some volatility from a technical sell off into the March option expiration though this pressure was quickly eased. The market soon recovered after the option expiration as expected. It all adds up to increased trading activity that in turn drives price choppiness.
Amidst increased volatility, “we are starting to get the focus and the trading that will lead to price discovery,” explained Oliver.
Each round of heightened trading activity and price discovery creates an opportunity for carbon prices to move higher. In Europe, the forecast for carbon allowance prices is around 140 euros per tonne according to Oliver. EUAs currently trade at half that as of mid-May.
Meanwhile, further tightening measures for the carbon market are under review in California. Emissions reductions would rise from the current 40% by 2030 to 48% over the same period. It’s a move that would remove existing market surpluses at a faster rate and likely prove favorable for California Carbon Allowance prices.
See also: “A Constructive Year for 2 Largest Carbon Markets”
Invest in Carbon Market Opportunities With KraneShares
The KraneShares California Carbon Allowance Strategy ETF (KCCA) offers targeted exposure to the joint California and Quebec carbon allowance markets. The market is one of the fastest-growing carbon allowance programs worldwide.
KCCA’s benchmark is the S&P Carbon Credit CCA Index. The CCA includes up to 15% of the cap-and-trade credits from Quebec’s market. The index tracks the most traded CCA futures contracts. The fund uses a wholly-owned subsidiary in the Cayman Islands to prevent investors from needing a K-1 for tax purposes. KCCA carries an expense ratio of 0.81%.
The KraneShares European Carbon Allowance Strategy ETF (KEUA) offers targeted exposure to the EU carbon allowances market and is actively managed. The fund’s benchmark is the S&P Carbon Credit EUA Index.
This benchmark tracks the most-traded EUA futures contracts, the oldest and most liquid carbon allowances market. Currently, the market covers roughly 40% of all EU emissions, including 27 member states and Norway, Iceland, and Liechtenstein. The fund carries a management fee of 0.79%.
For those investors seeking diversified exposure across the major carbon markets, the KraneShares Global Carbon ETF (KRBN) is worth consideration. The fund was the first of its kind to offer an investment take on carbon credits trading. KRBN tracks the S&P Global Carbon Index, which follows the world’s most liquid carbon credit futures contracts.
This includes contracts from the European Union Allowances (EUA) and California Carbon Allowances (CCA). It also includes the Regional Greenhouse Gas Initiative (RGGI) markets and the United Kingdom Allowances (UKA). KRBN carries a management fee of 0.79%.
For more news, information, and analysis, visit the Climate Insights Channel.