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Compliance markets are driven by cap-and-trade legislation, where governments set the price for corporations to buy credits to offset emissions.sharply_done/IStock

Investors seeking to profit from the rising price of carbon have growing choices among exchange-traded funds (ETFs) providing exposure to global carbon credit markets. However, market watchers warn these investments come with their share of volatility.

Four carbon credit ETFs recently launched in Canada, providing exposure to investments in cap-and-trade carbon allowances in the compliance markets, says Linda Ma, an analyst with National Bank of Canada Financial Markets in Toronto.

“They do not invest directly in carbon credits but instead provide exposure through futures contracts,” Ms. Ma says.

The Canadian funds include the Horizons Carbon Credit (CARB-T), the Ninepoint Partners’ Carbon Credit (CBON-NE), along with a U.S. dollar version (CBON-U-NE) – all launched in February – and the newest entrant, the TD Global Carbon Credit Index (TCBN-T), launched in August. All provide exposure to compliance carbon credit markets (those created and controlled by government entities) in places such as the European Union and California.

These markets are driven by cap-and-trade legislation, where governments set the price for corporations to buy credits to offset emissions. Companies under allowable emissions also earn credits that can then be sold to other companies. The largest compliance markets have been in place for several years, are collectively worth hundreds of billions of dollars, and have grown rapidly in recent years.

A 2021 Coherent Market Insights study estimates the global market will exceed US$2.4- trillion by 2027, up from US$211.5-billion in 2019.

The market is forecast to keep growing as governments worldwide are expected to lower emission limits, increasing demand and the price for credits, says Steen Rasmussen, Vancouver-based publisher of CarbonCredits.com.

“Overall, the macro view is bullish,” he says, pointing to reports forecasting rapid growth.

Still, investors expecting to capture this upside using ETFs should know the road to profitability will be bumpy, says Bobby Blue, senior manager and research analyst at Morningstar in Chicago.

“Our take is that it is a difficult proposition for investors to allocate capital to these (funds) in a risk-adjusted manner,” he says.

The uneven performance of U.S.-listed ETFs like the largest KraneShares Global Carbon Strategy ETF (KRBN-A) and the longest-running Barclays iPath Series B Carbon (GRN-A), an exchange-traded note (ETN), illustrate the risks and upsides.

GRN has traded since 2008 (under the name iPath Global Carbon ETN until 2018), tracking the futures market for the EU compliance market. For more than a decade, it was largely a losing investment.

Carbon markets gained momentum in 2019 with the EU Market Stability Reserve coming into effect, tightening credit supply, along with speculation a Green Deal was coming in the U.S. and lower emission targets for 2030, according to a Refinitiv report. This led to higher prices for credits, and GRN’s value increased more than 170 per cent in 2020 and 2021.

Yet the ETN, which is a debt instrument versus a fund structure like an ETF, has declined about 16 per cent, year to date. The decline is the result of two drawdowns, according to Ms. Ma. The first came at the start of the war in Ukraine “driven by many factors including investors’ profit taking and repositioning towards safe-haven assets,” she says.

The second occurred in August and September, sparked by a proposal to sell “a large chunk of carbon allowances from EU Market Stability Reserve” to help finance Europe’s exit from Russian gas, which would have “flooded” the credit market with more supply, Ms. Ma adds.

KRBN is the largest carbon credit ETF, with more than US$676-million in assets under management (AUM), covering markets for the EU, California, the U.K., and the Regional Greenhouse Gas Initiative, another U.S. market, and has had a similar performance arc.

After launching in 2020, its value grew nearly 108 per cent, but it is down about 26 per cent so far this year. Like GRN and other carbon ETFs, its slide is driven by energy inflation concerns.

“There is a lot of volatility short-term,” Mr. Rasmussen says. “We’re seeing that in the EU right now with natural gas from Russia being largely turned off, meaning more energy generation will come from coal… which is worse for the environment.”

The current conditions reveal the political facet of carbon credit markets, more so than other futures tracking volatile commodities like oil, Mr. Blue says.

“There is just a lot of political risk that hasn’t all bubbled to the surface yet,” he says.

Like KRBN, the TD and Nine Points ETFs, along with the U.S.-listed Carbon Strategy ETF (KARB-A) – the newest listing in the U.S. in September – offer exposure to global compliance markets.

Others, like GRN, focus on single compliance markets. That includes CARB, providing “exposure to just the European Allowance market,” Ms. Ma says, adding the EU is the most liquid, accounting for 90 per cent of the global market.

Kraneshares also has an ETF focused on Europe’s carbon market (KEUA-A) and another for California’s market (KCCA-A). It launched KraneShares Global Carbon Offset Strategy ETF (KSET-A) this spring, tracking the global voluntary carbon credit market. It is much smaller and more volatile than compliance markets, but with more long-term upside potential, Mr. Rasmussen notes.

Voluntary markets “are really for companies looking to achieve net-zero goals,” purchasing voluntary credits to offset emissions, he says, adding individuals also can buy credits to offset their carbon footprint.

“There are many market speculators who believe the overall price is going to go up” significantly in voluntary markets, he says.

Mr. Rasmussen adds that some reports predict high growth multiples, including a 2021 study by McKinsey & Company suggesting the voluntary market could grow 15 times its current size to US$50-billion by 2030.

Whether voluntary or compliance, Ms. Ma says these ETFs offer a low-cost way to invest, with management costs ranging from 65 to about 80 basis points, in carbon credits’ upside as climate change mitigation efforts increase.

While these ETFs are “interesting speculative instruments,” providing “phenomenal returns” in the recent past, she says investors should still consider them risky.

Mr. Blue says a case can be made for using these ETFs based on a particular market insight for short periods.

“But buy and hold [as a strategy] doesn’t make a lot of sense for these ETFs,” he says.

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Tickers mentioned in this story

Study and track financial data on any traded entity: click to open the full quote page. Data updated as of 14/03/24 8:00pm EDT.

SymbolName% changeLast
KEUA-A
KS European Carbon Allowance ETF
-0.5%21.43
KCCA-A
KS California Carbon Allowance ETF
+0.86%28.23
KSET-A
KS Global Carbon Offset Strategy ETF
+0.8%0.878
KARB-A
ETF Series Carbon Strategy ETF
+0.31%27.3
GRN-A
Ipath Series B Carbon ETN
-0.66%24.25
KRBN-A
Kfa Global Carbon ETF
+0.1%30.85
CARB-T
Horizons Carbon Credits ETF
-0.9%6.6
CBON-NE
Ninepoint Carbon Credit ETF
+0.4%22.32
TCBN-T
TD Global Carbon Credit Index ETF
-0.41%33.94
CBON-U-NE
Ninepoint Carbon Credit ETF
+0.55%16.45

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