Global markets have been wracked by volatility and uncertainty in recent weeks as the US eyes tariff retaliation. Times of volatility will often create great dislocations, which, for investors able to remain calm and identify these opportunities, can create strategic ways to reposition.

We believe California Carbon Allowances (CCAs), the $60bn asset class, to be one such opportunity.¹

The extreme market moves, as witnessed in equities since the announcement of new tariffs, have a habit of moving all correlations closer to 1, as margin calls in major asset classes lead to broad deleveraging.² In addition, an Executive Order (EO) was issued that targeted state-level climate policy, albeit with so little actionable content that California Governor Newsom called it a "glorified press release." Both of these factors pushed CCAs down to $26.³ So, what makes this potentially oversold opportunity more compelling than other dislocations we’ve seen in these markets?

California Carbon Allowances have an implicit floor price as well as a ceiling price. That floor price today is $25.87, almost exactly where spot prices are. With a ceiling of $94.92 and first resistance at $60.47, CCAs are lined up to offer strong downside support with potentially high upside – and that is just half of the story. The other half is that the floor price steps up each year by 5% plus the Consumer Price Index (CPI)⁴ print. If we assume a 3% CPI, that would equate to an 8% uplift each year from these levels as a base case. If we expected inflation to increase, then this strategy would keep pace.

We believe the downside floor, inflation adjustment plus an additional 5% annual step up, and potential for material upside make CCAs highly attractive at these levels.

Historically, when prices have fallen below the floor, CCAs have shown to quickly bounce back. The last time we saw this happen was in March 2020 during the initial shocks of the COVID pandemic when there was widespread panic selling that led to prices selling off below the floor. However, this was short-lived, as CCAs quickly started to rebound after a week and were above the floor by early May. The market then went on to post an impressive rally, up 40% one year out from that March low.⁵

What’s Next:

In terms of the EO, the Attorney General has 60 days to review and submit a report with their recommendations.⁶ The EO specifically mentions initiatives in New York, Vermont, and California, which have implemented measures including imposing fines on fossil fuel companies for climate-related damage and/or adopting caps on emissions. At the baseline, state climate lawsuits are heard in state courts by state judges who determine if federal intervention is needed. Federal intervention should not be able to hit state policies, but policies that extend to multiple states (i.e., RGGI) could be more vulnerable by their interstate nature. We have seen these programs tested in the past, with Trump targeting the California cap-and-trade program’s link to Quebec under his last term, though it made little headway in court and was dismissed. We have outlined other challenges and potential political implications to cap-and-trade in our report here.

In addition to the Governor's initial statement, Newsom, alongside acting Senate President Mike McGuire and Assembly Speaker Robert Rivasc, collectively announced their intentions to approve the extension of the program beyond 2030 by the end of the current legislative year. This collaboration marks a galvanizing moment as it marks the first time in 5 years that all key players are working together in their commitment toward reauthorizing the program. We also saw a rebuke of the EO with a coalition of 24 Governors stating that this move was an overreach of Federal Authority with plans to fight back.⁷

More than likely, any pushback from the Attorney General will be fought in court, and the proceedings will take several months to years. Newsom already secured a $50 million litigation fund to help defend against the Trump administration, with $25 million proposed to go to the state Department of Justice to fight the federal government in court.⁸ Realistically, there are two potential avenues that the Attorney General could find the California cap-and-trade program unconstitutional: 1) contest the link with Quebec under the Western Climate Initiative (WCI) under the Compact Clause for a second time, 2) out-of-state power generators under the Commerce Clause. In either case, the program would not get shut down but would simply end ties with Quebec or exclude that power exposure, where both would have a very minimal impact on the market.

Our view is that Dec’25 CCA futures should be saved from any delivery risk. With the EO lacking specifics and the California state program well protected, we believe this is an opportunity to add to positions that could benefit from when the market rationalizes and potentially creates a more attractive upside/downside scenario.

CCA Reform Drives Supply Scarcity

The next big-ticket item for CCAs is for the market regulator, the California Air Resource Board (CARB), to finalize the ongoing cap-and-trade reform package, which introduces new policies designed to accelerate supply tightening out to 2030 to better align the market with the more ambitious state emissions targets. The next step in this rulemaking process is the Initial Statement of Reasons (ISOR) report, which outlines the purpose, justification, and expected impacts of proposed regulatory changes, serving as the official rationale behind CARB’s amendments to the cap-and-trade Program. This ISOR step is required to then get official approval before implementing the new policies.

Cap-and-trade programs typically begin with an oversupply of carbon allowances to keep prices manageable and give regulated companies time to adapt. Over the years, however, regulators gradually reduced the number of allowances available, creating tighter supply conditions that push prices higher and increase the cost of emitting carbon.

After several years of growing surplus, we are entering a turning point, with excess allowances starting to shrink. In other words, the market is heading into a period of tightening supply. A significant drop in surplus is projected for 2026, and this shift is expected to become a key catalyst for higher CCA prices, with investors likely to begin pricing in this supply tightening this year once we receive more clarity on the reform.

Last year, we saw this rulemaking delayed by a year, which was largely believed to be in part due to a focus on first completing California’s Low Carbon Fuel Standard (LCFS) reform coupled with weighing potential impacts from the federal election and the wildfires. LCFS is another crediting program designed to encourage the use of more sustainable fuels. However, CARB has recently made significant progress toward closing out the LCFS rulemaking, which we think shows an appetite to clear the decks to focus on CCA and potentially shows a drive to get things done while eyes are on traditional markets.

CARB’s initial LCFS rulemaking required revisions as requested by the Office of Administrative Law (OAL). Following the OAL’s notice, CARB had 120 days to resubmit the amended proposal, although it only took 45 days to revise the package. As it stands, the proposal is subject to a 15-day public comment period, after which it can be resubmitted to the OAL for final approval.⁸

Why Now:

The California carbon market has weathered political pushback, macroeconomic stress, and regulatory noise before and come out stronger. The CCA market has consistently demonstrated its resilience and is reinforced by steadfast state leadership. CCAs are now trading near the floor, and the KraneShares California Carbon Allowance Strategy ETF (Ticker: KCCA) is down 17.1% year-to-date and 9.3% month-to-date.⁹ Amid broader market volatility, we believe KCCA presents a strategic play for investors searching for a risk asset, especially given its unique structural advantages.

The performance data quoted represents past performance. Past performance does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed or sold, may be worth more or less than the original cost. Current performance may be lower or higher than the performance quoted. For performance data current to the last month-end, please visit KCCA.

For KCCA top 10 holdings, risks, and other fund information, please click here.

---

1. Data from Bloomberg as of 12/31/2024.
2. Bank for International Settlement, "Evaluating changes in correlations during periods of high market volatility," June 2000; Reuters, "Hedge funds capitulate, investors brace for margin calls in market rout," April 7, 2025.
3. Data from Bloomberg as of 4/11/2025.
4. Consumer Price Index (CPI)
5. Data from Bloomberg, retrieved 4/11/2025.
6. Whitehouse.gov, “PROTECTING AMERICAN ENERGY FROM STATE OVERREACH,” April 8, 2025
7. US Climate Alliance, “U.S. Climate Alliance Co-Chairs, Govs. Hochul and Lujan Grisham, Issue Statement on President’s Executive Order Targeting State Authority” April 9, 2025
8. Politico, "Gavin Newsom and California Democrats reach $50M deal to Trump-proof the state," 1/13/2025.
9. Carbon Pulse, LCFS prices rip higher as ARB releases third 15-day notice in administrative approval effort,” April 4, 2025
10. Data from Bloomberg as of 4/11/2025.