almost 3 years ago • 3 mins
British hedge fund Andurand Capital Management delivered returns of 154% in 2020 – mainly thanks to a hugely successful bet on oil’s spectacular crash. And its latest big bet is also energy-related: Andurand is just one of many major funds to have built a significant position in emissions trading markets markets recently.
I thought it’d be interesting to investigate why the price of carbon credits has doubled over the past year – as well as how you can join the likes of Andurand in hoping that they’ll double again over the next decade.
The oldest and largest greenhouse gas emissions trading market in the world was created by the European Union (EU) in 2005 in a bid to battle global warming. Its “cap-and-trade” mechanism limits the amount of greenhouse gases permitted to be emitted by 11,000 factories and power plants across Europe, while allowing companies to buy and sell excess allowances.
The system, like similar schemes rolling out in places such as California, forces heavy polluters to buy carbon “credits” from firms with lower emissions. The higher their price, the greater the cost for heavy polluters – and the greater the incentive for them to cut their emissions.
So much for the market. But there are three main reasons why investors have been growing increasingly interested in carbon prices’ potential as a source of profit:
While demand for carbon allowances is growing significantly, supply is tightly controlled by the EU – and the gatekeeper has an interest in seeing prices rise still higher. According to many estimates, a carbon price between $50 and $100 is needed to meet the Paris Agreement’s 2030 climate change targets – and it’s currently right at the bottom of that range.
Huge inflows into the KFA Global Carbon ETF, the main carbon exchange-traded fund, mean its assets under management have risen from $3 million six months ago to $60 million today. Until recently, carbon prices were mostly driven by industrial, power, and utilities companies’ buying and selling, as well as hedge fund speculation – but this is changing. Booming demand for green investments may well attract more large institutional investment to the market, potentially rewarding retail investors who get in beforehand.
In a world where diversification is scarce, carbon markets offer historically low correlation with the prices of bonds, US stocks, and even commodities. Emissions trading has shrugged off the impact of the pandemic – although I wouldn’t count on it being entirely immune from broader market selloffs in the future.
Carbon credit trading isn’t without risks. For one thing, the EU’s close control of supply means that a surprise increase in allowances – perhaps in response to a too-high price threatening local companies’ competitiveness – could blindside investors. The rapid recent price rise, meanwhile, has stoked fears among some that a bubble is forming.
Few investment markets offer the chance to have such a directly positive impact on climate change as emissions trading. Higher carbon prices simultaneously compel heavy polluters to cut their emissions while at the same time making investments in green technology more profitable. By going long on carbon, you’re supporting a greener future for the planet – and potentially for your portfolio
For investors with access to US markets, the KFA Global Carbon ETF mentioned above (ticker: KRBN) is the easiest way to make this play. The fund tracks some of the world’s most-traded carbon credit futures contracts, with a 65% exposure to the European market and the remainder split between California and other regions.
And while there’s no equivalent ETF on the other side of the Atlantic, both US and European investors can also gain exposure through contracts for difference (CFDs) and spread bets on carbon emissions – although the usual warnings apply with these highly leveraged alternatives.
Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.