Investing in Carbon Markets: Helping the Planet or Speculating?
Introduction
Investing in the carbon market has become a popular option for investors looking to make a positive impact on the environment while also potentially reaping financial rewards. The concept behind the carbon market is simple: by requiring polluters to hold an emission quota (EUA) to emit a ton of carbon dioxide, the price of carbon rises, incentivizing companies to reduce their emissions. Retail investors in the UK now have the opportunity to buy exchange-traded funds (ETFs) that track the carbon price in the EU emissions trading system. But are these investments truly helping the planet or are they merely catering to ruthless speculators?
The Products Available
There are currently two main products available to UK-based retail investors interested in the carbon market: WisdomTree Carbon ETC and SparkChange Physical Carbon EUA ETC. These funds allow investors to gain exposure to the carbon price and potentially benefit from its rise over time. WisdomTree also offers a third fund that focuses on the smaller carbon market in California. These funds are designed to provide investors with total return exposure to carbon futures contracts.
The Investment Case
The investment case for buying a fund tied to the carbon price is that it should go up. The EU plans to release fewer EUAs in the coming years, aiming to raise the price to the point where it impacts capital spending decisions by power companies and other polluters. The EU also plans to expand the carbon market to cover more sectors, reducing the number of free allowances given out to appease the industry. Analysts expect the price of carbon to rise in the coming years, with projections of reaching 144 euros by 2030. However, volatility is high in the carbon market, making it a speculative investment.
Sustainability of ETCs
Both WisdomTree and SparkChange argue that their ETCs have sustainability benefits. SparkChange, as a physically secured fund, believes its product has a greater environmental impact by effectively owning the EUA, taking it off the market and limiting supply for polluters. WisdomTree, on the other hand, focuses on the potential return linked to the case of rising carbon prices and argues that a more liquid market will lead to better and more efficient pricing. The sustainability of these investments is still a matter of debate, with skeptics questioning the effectiveness of the carbon market and its ability to drive meaningful change.
Opinions and Perspectives
Opinions on investing in carbon markets vary. Some investors prefer to avoid oil and gas companies altogether, while others see engaging with the carbon market as a way to make a positive impact. Retail investors need to consider the regulatory decisions that influence carbon prices and the volatility of the market before investing. However, some asset managers believe that these investments can provide diversification to portfolios and serve as a potential buying opportunity during declines.
Conclusion
Investing in the carbon market as a retail investor comes with its pros and cons. While there is a potential for financial gains as the carbon price rises, there is also inherent volatility and uncertainty. The sustainability impact of these investments is still up for debate, with some arguing that more sectors need to be included in the carbon market to make a significant difference. Regardless, the global regulatory advantage for carbon markets is likely to increase, making these investments more appealing in the future.
Additional Piece: Exploring the Potential of Carbon Markets
Carbon markets have emerged as a mechanism to tackle climate change by creating financial incentives for companies to reduce their carbon emissions. While there are debates about the effectiveness of these markets in driving meaningful change, they have the potential to play a crucial role in transitioning to a low-carbon economy. Let’s take a deeper dive into the concept of carbon markets and explore their potential benefits and challenges.
1. Driving Innovation and Investment in Renewable Energy
One of the key arguments in favor of carbon markets is their ability to drive innovation and investment in renewable energy. By putting a price on carbon emissions, companies are incentivized to reduce their carbon footprint and explore cleaner alternatives. This creates a market demand for renewable energy technologies and encourages companies to invest in research and development to find more sustainable solutions.
2. Encouraging Carbon Offsetting and Nature-Based Solutions
Carbon markets also provide a platform for companies to offset their emissions through carbon credits. By investing in nature-based solutions such as reforestation projects or funding renewable energy projects in developing countries, companies can offset their own emissions and contribute to global carbon reduction efforts. This not only helps to balance the emissions ledger but also supports sustainable development in vulnerable regions.
3. Promoting International Collaboration and Cooperation
Carbon markets can also foster international collaboration and cooperation in tackling climate change. With global participation, countries can trade emissions allowances and work together to reduce emissions collectively. This can help bridge the gap between developed and developing countries, encouraging the adoption of cleaner technologies and practices worldwide.
Challenges and Considerations
While carbon markets have the potential to drive positive change, they also face several challenges and considerations:
1. Market Volatility and Regulatory Uncertainty
As seen in recent market fluctuations, carbon prices can be highly volatile, making it a risky investment for retail investors. Moreover, regulatory decisions play a significant role in determining the carbon price, making it unpredictable for investors.
2. The Need for Strong Regulation and Enforcement
For carbon markets to be effective, there is a need for robust regulation and enforcement mechanisms to ensure that emissions are accurately measured and reported. This requires transparent monitoring systems and penalties for non-compliance to prevent fraud and market manipulation.
3. Inclusion of All Sectors and Global Coverage
To achieve meaningful emissions reductions, it is crucial to include all sectors in the carbon market and expand its coverage globally. Currently, the EU emissions trading system mainly applies to power companies and energy-intensive industries. Expanding the market to other sectors, such as transportation and agriculture, can further drive emission reductions.
4. Addressing Equity and Environmental Justice Concerns
Carbon markets should also address equity and environmental justice concerns. Low-income communities and marginalized groups often bear the brunt of environmental pollution and climate change impacts. It is essential to ensure that carbon market mechanisms do not disproportionately burden these communities and instead support a just transition to a low-carbon future.
Conclusion
While there are debates and challenges surrounding carbon markets, they have the potential to incentivize emission reductions, drive innovation in renewable energy, and promote international cooperation. However, for these markets to be truly effective, they need strong regulation, broader sector coverage, and a focus on environmental justice. Investors interested in the carbon market must carefully consider the risks and uncertainties associated with this emerging market. Overall, carbon markets can be seen as a tool in the broader toolbox of climate change mitigation efforts, but they are not a panacea.
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If you are an investor in the carbon market, are you helping the planet? Or are you just a ruthless speculator?
From 2021, it is possible for UK retail investors to buy exchange-traded funds that track the carbon price in the EU emissions trading system. By requiring polluters to hold an emission quota (EUA) to emit a ton of carbon dioxide, the idea is that as the price rises, companies will have an incentive to reduce emissions, for example by investing more in renewable energy. Companies that don’t need their permits, ideally because they emit less, are free to sell them on the open market.
There are two main products available to UK-based retail investors: WisdomTree Carbon ETC and SparkChange Physical Carbon EUA ETC. (A third, also by WisdomTree, was established in April of this year and follows the much smaller carbon market in California.)
The investment case for buying a fund tied to the carbon price is that it should go up. The EU plans to release fewer EUAs in the coming years with plans to raise the price to the point where it impacts capital spending decisions by power companies and other polluters and to reduce the number of free allowances it has given out to appease the industry. It also plans to expand the scheme to cover more sectors. At present, it mainly applies to power companies and energy-intensive industries.
Having has reached €100 in February – a price that could focus the mind on changing behavior – the price is now at €95 after a steep climb over the past two weeks. The performance of exchange traded commodities (ETCs) was subdued in the 12 months to early June, according to Morningstar data. At 4-5 percent, this significantly underperforms the major stock markets.
However, analysts expect the price to rise well beyond its current levels in the coming years. By 2030, they expect it to reach an average of 144 euros, according to a survey by Carbon Pulsealthough they expect just €102 by 2025, not far from the level reached in February this year.
Volatility is high: A fact sheet from the SparkChange fund shows that while EUA prices have risen 28.5% in 2020, for example, volatility has been over 51%. The previous year, volatility was still 41%, but the price increase was only 1%. This compares with stock index volatility levels which tend to be in the mid-teens.
The price of EUAs is closely linked to the price of gas, which has seen a huge increase of more than 100% this month, leading to a corresponding increase in carbon prices from €78 to €95. Mark Lewis, Head of Climate Research at Andurand Capital Management, a hedge fund, he says this “has been one of the most volatile periods we’ve seen since last summer.”
For some asset managers, these swings take products off the table for retail investors. “These products are somewhat speculative, we don’t really know what’s going to happen with them, and they’re new,” says Peter Sleep, senior portfolio manager at 7IM.
But are any of these ETCs a sustainable investment?
SparkChange argues that as a physically secured fund, its product has a greater environmental impact than a futures-based product, because the fund effectively owns the EUA, taking it off the market and limiting supply for polluters. Handelsbanken, for example, holds ETC in its sustainable investor portfolio for these reasons.
The sustainability case of the WisdomTree ETC is a bit different. The factsheet focuses on the potential return linked to the case of rising carbon prices, stating that the fund is “designed to provide investors with total return exposure to carbon futures contracts.”
Where it can contribute sustainably is by introducing more liquidity into the market, WisdomTree argues: A more liquid market will in theory lead to better and more efficient pricing. “The social cost of an undervalued carbon futures contract is carbon overproduction,” she says in her investment case for the fund.
Billal Ismail, head of sales at SparkChange, says most investors in his ETC are institutions including asset managers and pension funds, who hold it long-term. He argues that carbon price volatility, driven partly by weather fluctuations, partly by the fact that utilities are the largest buyers of EUAs and are price independent, means that for long-term investors, declines are buying opportunity.
Carbon markets also have their thing: they have a low level of correlation with other asset classes, so they may appeal to investors looking to balance their portfolio. Cormac Nevin, fund manager at You Asset Management, says this is one of the main reasons he holds the fund in various multi-asset portfolios, including a cautious one.
However, Tara Clee, a sustainability analyst at Hargreaves Lansdown says both ETCs are held in very small quantities by clients on the trading platform. “Until the carbon price increases substantially and most sectors are included in the ETS, the effectiveness of the scheme in terms of sustainability is in question,” he says, but adds: “These products would be good for clients looking to gain exposure to decarbonisation, and it is clear that the global regulatory advantage will only increase the use case for these ETFs.”
Investing in carbon markets likely won’t appeal to sustainability purists in the same way that buying Shell stock in the hopes of pressurizing it to cut emissions faster won’t either. Some investors prefer not to be contaminated by oil and gas companies at all. Others may feel that engaging with the carbon market can help expand it.
Others still see it as an energy transition game: you don’t need to assess sustainability to see that there’s a good investment in this area. But with the price still tied to regulatory decisions and the market relatively illiquid and volatile, only brave retail investors should dare to step in.
Alice Ross is a contributor to FT. Her book, “Investing to Save the Planet,” is published by Penguin Business. Chirping: @aliceemross
https://www.ft.com/content/184ec1d1-a8e8-45e5-98ca-9a84e83d5f09
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