Key Takeaways

• Exchange Traded Funds and other instruments that hold compliance carbon market futures began appearing in 2019 and have steadily gained momentum since.
• Many carbon market ETFs trade dominantly in the EU ETS because of its larger scale and greater liquidity.
• Most carbon market ETFs are facing questions as to how to proceed amidst increased volatility in EUAs and price dips across the majority of carbon markets for most of 2022.

Origins of Carbon Market ETFs

One of the key features of the carbon market, from the perspective of a potential investor, is its relative difficulty to access. Whether it is California or the European Union, one must register with the market if one wishes to participate, a process that is not necessarily easy. In order to provide an easier route for retail investors to access the growing opportunity in carbon markets, financial entities such as banks and asset management companies began issuing ETFs and other instruments, some as early as 2017. Barclays Bank was the first financial entity to offer access to the compliance carbon markets with the iPath Global Carbon Exchange-Traded Note (ETN) in 2017. This ETN was linked to the Barclays Global Carbon II TR USD Index which held futures in the EU ETS as well as the Kyoto Protocol CDM mechanisms.¹ The original iPath ETN was replaced in 2019 with the iPath Series B Carbon ETN which functions very similarly and is traded on the NYSE ARCA. Today this ETN holds 99.9% European Union Allowances (EUAs).² Although Barclay’s iPath ETN was first on the scene, the first true exchange-traded fund (ETF) with exposure to compliance carbon markets was Kraneshares’ Global Carbon Strategy ETF (KRBN). KRBN is composed mostly of EUA futures, but also holds California, UK, and RGGI allowance futures.³ Kraneshares’ KRBN is the largest carbon market ETF with nearly three-quarters of a billion dollars’ worth of assets, and in 2021 was one of the most successful ETFs in the US with a 108% return.⁴ The success of the KRBN ETF in 2021 is an important factor when looking at the recent influx of new ETFs in 2022, despite a rocky macro-economic landscape.

ETFs gaining momentum

The majority of carbon market ETFs have emerged in the past year, as global carbon markets have become a greater source of interest for the financial community. At the beginning of 2022, the EU ETS alone constituted a €683 billion market, a value that financial entities have increasingly sought to access.⁵ Kraneshares has launched three new carbon market ETFs since October of 2021, each with a specific focus on one market: Europe, California, and a fund trading exclusively in voluntary offset credit futures, currently the only ETF to do so. In the same time span, three financial entities from Canada and two from Asia have also entered the market, several trading exclusively in EUA futures. In addition to ETFs, the London Stock Exchange has seen the listing of two EUA-based exchange-traded commodities (ETCs) in the past year as well. One of these, Wisdom Tree Carbon ETC functions in a similar fashion to the Barclays iPath ETN mentioned previously, and tracks the Solactive Carbon Emission Allowances Rolling Futures Index for EUA ICE futures. The second, HanETF’s SparkChange Physical Carbon EUA ETC is actually backed by physical EUAs, the only fund in this article that does not trade in allowance futures.

Focus on EUAs

Because of its size and liquidity, the EU ETS has been far and away the favorite investment market for all the ETFs mentioned thus far. Only Kraneshare’s KRBN and KCCA, Ninepoint’s CBON, and the recent arrival KARB Carbon Strategy ETF have any kind of significant exposure to other markets such as California and RGGI. The growing momentum from fall 2021 through early spring of 2022 in EUA-centric ETFs, however, is only part of the story. The EU ETS, as many know, has not seen the same kind of market growth thus far in 2022 as it did in 2021. The tightening macro-economic situation, coupled with an energy crisis brought on by the Russian-Ukraine war, has caused a fall in the price of EUAs and given rise to significant volatility. As a recent NASDAQ article points out, “(EU) Carbon prices have… moved in correlation to the energy markets for much of 2022, rising to a high of €99.22 in mid-August before declining to €66.08 in the first half of September; current prices are hovering around €71.”⁶ Of the thirteen funds identified in the charts below, only one has maintained a positive balance sheet over the past year to date.

ETFs Looking Forward

Despite the current losses and volatility associated with most of the carbon market ETFs, many believe that in the long run there is still significant investment opportunity. Even in the face of a bearish economy, the past two months have seen the inception of two new funds: TD’s Global Carbon Credit Index ETF (TCBN) was listed on the Toronto Stock Exchange in August, and KARB’s Carbon Strategy ETF (KARB) was listed on the NYSE ARCA only three weeks ago. Many see ETFs as a long play and are relying on the general global momentum towards decarbonization to continue despite short to medium term setbacks. Looking forward, some of the largest carbon markets in the world have still seen limited or no activity in the ETF space. China, the world’s largest carbon marketplace, remains untouched by western ETF investment. Whether this is likely to change in the near term is hard to say, but Kraneshares would likely be the first involved in such a market given their established position in other Chinese investment strategies. In addition to this, the voluntary carbon market (VCM) has also seen only limited investment thus far, although the ProShares Carbon Offsets Strategy ETF (OFFS) is hoping to enter the market in the near future to compete with Kraneshare’s KSET, currently the only active VCM ETF. Overall, carbon market ETF investment already constitutes nearly $1.5 billion dollars. While the current moment of uncertainty for the EU ETS has caused some re-positioning among investors, it is hard to imagine the momentum for retail investment in carbon markets slowing down too much in the long term.

ETFs 2022

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