What’s Driving Unprecedented Growth in Carbon Markets
By Oktay Kurbanov and Eron Bloomgarden, Partners at Climate Finance Partners (CLIFI)
Please Register to Download this Report
Despite the challenges presented by geopolitical upheaval, energy crises, and economic pressures, 2022 proved to be a pivotal year for carbon markets. With increasing regulatory support and political momentum, carbon markets achieved several noteworthy successes. These include multiple supply-tightening measures and expansion in the scope of the EU Emissions Trading System (ETS) and California’s 20% increase in its emission reduction ambition. Moreover, in a year marked by difficulties, carbon markets proved their resilience and diversifying* value by outperforming equity markets, with the IHS Global Carbon Index surpassing MSCI World by 9.2% in 2022.1 As we move forward, we can expect carbon markets to continue expanding, cementing their position as a vital component in the global effort to decarbonize.
Through the KraneShares Global Carbon Strategy ETF (Ticker: KRBN), investors can allocate toward the four largest, most liquid carbon markets. To learn more, the “What’s Driving Unprecedented Growth in Carbon Markets” whitepaper serves as a comprehensive resource on the dynamics of carbon allowance programs, the potential benefits of a portfolio allocation, as well as the impact case for investment in carbon allowances.
The whitepaper includes the following:
- Primer on the four largest carbon cap-and-trade programs
- Breakdown of each market’s regulatory mechanisms and recent liquidity
- Carbon price as an economic driver for decarbonization
- Potential performance and diversification benefits from carbon allocations
*Diversification does not ensure a profit or guarantee against a loss.
1. Data from Bloomberg as of 12/31/2022.
Index/ Term Definitions:
MSCI World Index: is a broad global equity index that represents large and mid-cap equity performance across 23 developed markets countries. It covers approximately 85% of the free float-adjusted market capitalization in each country, and MSCI world index does not offer exposure to emerging markets.
IHS Global Carbon Index: tracks the most liquid segment of the tradable carbon credit futures markets. Constituents of the Global Carbon Index include futures contracts on European Union Allowances (EUA), UK Allowances (UKA), California Carbon Allowances (CCA), and the Regional Greenhouse Gas Initiative (RGGI), with pricing data from ICE Futures Pricing.
S&P 500: Standard & Poor’s Index is a capitalization-weighted index of 500 stocks.
Bloomberg Barclays US Aggregate Bond Index (”The Agg”): A broad base, market capitalization-weighted bond market index representing intermediate term investment grade bonds traded in the United States. Inception date: January 1, 1986.
The S&P GSCI: A composite index of commodities that measures the performance of the commodity market. Inception date: May 7, 2007.
EuroStoxx 50 index: represents the performance of the 50 largest companies among the 20 supersectors in terms of free-float market cap in Eurozone countries.
Sharpe ratio: Used to help investors understand the return of an investment compared to its risk. Generally, the greater the value of the Sharpe ratio, the more attractive the risk-adjusted return.
Volatility: the degree of variation of a trading price series over time as measured by the standard deviation of returns. Standard deviation is a quantity calculated to indicate the extent of deviation for a group as a whole. A low standard deviation indicates that the data points tend to be close to the mean (also called the expected value) of the set, while a high standard deviation indicates that the data points are spread out over a wider range of values.
Correlation: The degree to which two data series move with one another, usually expressed as R2 from -1 to 1, where a number below zero indicates an inverse relationship between the two datasets or that the two datasets move inversely to some extent, zero means no relationship between the two, and a positive number indicates that the datasets are somewhat related or move together to some extent.
Major asset classes’ material differences from carbon allowances
Investment Material Differences
Carbon Allowance Futures Contracts Carbon futures contracts are deliverable contracts where each Clearing Member with a position open at the cessation of trading for a contract month is obliged to make or take delivery of Carbon Emission Allowances to or from the regional regulatory body in accordance with the ICE Futures Regulations. Specific risks are discussed below.
Equities The risks of investing in equity include share price falls, receiving no dividends, or receiving dividends lower in value than expected. They also include the risk that a company restructures may make it less profitable. Alternatively, a company may fail. If this happens, you may be at the end of a long list of creditors and therefore risk not getting the value of your investment back.
Bonds Bonds are subject to interest rate risk and will decline in value as interest rates rise. Other risks include, but are not limited to, reinvestment, inflation, credit/default, ratings downgrades, and liquidity risks.
Commodities Investments in commodities are subject to higher volatility than more traditional investments. Commodity price risk is the possibility that commodity price changes will cause financial losses for the buyers or producers of a commodity.