Climate change is real, it is the result of human activity, and much of the damage may be irreversible, according to the latest scientific assessment from the United Nations Intergovernmental Panel on Climate Change, released this past week.
This isn’t news to many investors. Regulators and American corporations have been calling to put a dollar figure on the price of carbon-dioxide emissions, the biggest contributor to climate change. A new exchange-traded fund is poised to let investors participate in the increasingly robust market.
As countries vow to reach net-zero carbon emissions in the next few decades, “cap and trade” programs are getting more traction. These programs limit, or cap, how much carbon dioxide each company can emit. Those that exceed the threshold will have to purchase extra permits from those that pollute less. The caps are expected to drop over years, which will reduce the supply of carbon permits and drive up prices. As it becomes more expensive to emit greenhouse gases, polluting companies should be motivated to cut emissions by transforming their business or developing new technologies.
Carbon cap-and-trade programs have been around for more than a decade but have languished due to low demand, whipsaw volatility, and poor liquidity. All that has improved recently, and will continue as these programs become more established.
The $579 million
KraneShares Global Carbon
ETF (ticker: KRBN), which launched a year ago, holds the most-traded carbon-credits futures contracts on major markets in Europe and the U.S. The fund has soared 84% since it started trading, currently reflecting a weighted carbon price of $37 per ton of carbon dioxide.
The run-up was largely due to the passage of European Green Deal, says Trevor Sikorski, head of carbon research at consulting firm Energy Aspects: “It goes far beyond just some long-term goals—it’s now a very concrete set of proposals that would make the caps a lot harder to meet.”
Still, current prices are far below the level needed to accelerate a low-carbon transition fast enough. The Organization for Economic Cooperation and Development estimates that $147 per ton is needed by 2030 if the world hopes to reach net-zero carbon emissions by 2050. That means more-aggressive policies are likely coming.
“These markets are designed to increase over time,” says Eron Bloomgardenn of Climate Finance Partners, subadviser of the KraneShares ETF.
Policy tailwinds won’t eliminate volatility, though. Economic cycles, the weather, and fluctuating prices in other energy commodities could all affect the carbon market’s short-term price movements, says Ariel Perez, head of environmental products at commodities-trading firm Hartree Partners. Wider adoption of carbon-reducing technology could also drive down demand significantly, but that likely won’t happen until prices reach a much higher level.
Institutional investors and hedge funds have used carbon futures as a diversifier due to their low correlation with traditional asset classes like stocks and bonds, says Luke Oliver, KraneShares’ head of strategy.
Carbon futures can also be an efficient hedge against energy transition risk, says Perez: “If carbon prices go up, it will drag on the energy-intensive companies and increase the cost of living for all of us.”
More carbon markets could be added to the KraneShares ETF if they reach size and liquidity requirements, creating a more-diversified portfolio. The U.K. market is expected to be added in November, Oliver told Barron’s, and markets in South Korea and New Zealand are also under close watch.
China just launched its own carbon-trading plan last month, which could eventually become the largest carbon market in the world: There is a lot more carbon to capture, and a lot more upside to be realized.
Write to Evie Liu at email@example.com