If you are an investor in the carbon market, are you helping the planet? Or are you just a reckless speculator?
From 2021, retail investors in the UK can buy exchange-traded funds that track the EU’s carbon price. emissions trading System. By requiring polluters to hold an emission allowance (EUA) to emit one tonne of carbon dioxide, the idea is that as the price rises, companies will be incentivized 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 for UK-based retail investors: WisdomTree Carbon ETC and SparkChange Physical Carbon EUA ETC. (A third, also from WisdomTree, was founded this April and tracks the much smaller carbon market in California.)
The investment case for buying a carbon price linked fund is that it is expected to rise. The EU plans to release fewer EUA allowances in coming years, with the intention of raising the price to the point that it affects capital spending decisions by energy companies and other polluters – and reducing the number of free allowances it has given away to appease the industry. It also plans to expand the scheme to cover more sectors. At the moment, it mainly concerns energy companies and energy-intensive industries.
Have reached €100 in February – a price that could focus attention on a change in behavior – the price is now at €95 after a sharp rise in the past two weeks. The performance of exchange-traded commodities (ETCs) was muted in the 12 months to early June, according to data from Morningstar. At 4 to 5 percent, it lags well behind the major equity markets.
However, analysts predict that the price will rise significantly above current levels in the coming years. They expect it to reach an average of €144 by 2030 Carbon Pulse surveyalthough they only forecast €102 by 2025 – not far from the level reached in February this year.
Volatility is high – the SparkChange fund fact sheet shows that while, for example, EUA allowance prices rose by 28.5 per cent in 2020, volatility was more than 51 per cent. In the previous year, volatility was still 41 percent, but the price increase was just 1 percent. This is comparable to the volatility levels for equity indices, which tend to be middle-aged.
The price of allowances is closely tied to the price of gas, which saw a huge increase of more than 100 percent this month, leading to a corresponding rise in carbon prices from €78 to €95. Mark Lewis, head of climate research at Andurand Capital Management, a hedge fund, says it “has been one of the most volatile periods we’ve seen since last summer”.
For some wealth managers, these fluctuations take products off the table for retail investors. “These products are kind of 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 claims that as a physically hedged fund, its product has a greater environmental impact than a futures-based product because the fund actually holds EUAs, withdrawing them from the market and limiting the supply for polluters. Handelsbanken, for example, holds ETC in its sustainable portfolio for investors for these reasons.
The WisdomTree ETC sustainability case is a bit different. Focusing on the potential for returns in the event of a carbon price increase, the fact sheet states that the fund is “designed to provide investors with the total return of carbon futures contracts”.
Where it can make a sustainable contribution, WisdomTree says, is by introducing more liquidity to the market: a more liquid market will theoretically lead to better and more efficient prices. “The social cost of an undervalued emissions futures contract is carbon overproduction,” it says in its investment case for the fund.
Billal Ismail, head of sales at SparkChange, says most investors in ETC are institutions including wealth managers and pension funds who hold them for the long term. He argues that the volatility of the carbon price – caused in part by weather fluctuations, in part by the fact that energy companies are the biggest buyers of EUA allowances and are price agnostic – means dips are buying opportunities for longer-term investors.
Carbon markets also do their own thing: they have a low level of correlation with other asset classes, so they can appeal to investors looking to balance their portfolios. Cormac Nevin, fund manager at You Asset Management, says this is one of the key reasons he holds the fund across a variety of multi-asset portfolios, including one cautious one.
Still, Tara Clee, sustainability analyst at Hargreaves Lansdown, says both ETCs are held by clients on the trading platform in very small amounts. “Until the price of carbon increases substantially and most sectors are included in the ETS, the effectiveness of the system in terms of sustainability will be up for debate,” he says, but adds: “These products would be good for clients who want exposure to decarbonisation. and it is clear that global regulatory tailwinds will only increase the use of these ETFs.”
Investing in carbon markets is unlikely to appeal to sustainability advocates as much as buying shares in Shell in the hope of pressuring it to cut emissions faster. Some investors prefer not to be tainted by oil and gas companies at all. Others may argue that involvement in the carbon market can help expand it.
Others still see it as an energy transition play: you don’t have to value sustainability to see that there is a good investment case in this area. But with the price still tied to regulatory decisions and the market relatively illiquid and volatile, only brave retail investors should venture in.
Alice Ross is a contributor to the FT. Her book “Investment to Save the Planet” was published by Penguin Business. Twitter: @aliceemross