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Five things you need to know about carbon emissions trading

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The price of carbon has almost doubled since the beginning of the year, rising from about €35 per tonne in January to a high of almost €65 in September.

#1. The price of carbon

Carbon pricing is fundamentally a regulatory tool aimed at cutting emissions and increasing international focus on climate issues. Events like COP26 in Glasgow keep leading to changes in regulation that are nudging prices higher. According to some analysts, the price of carbon would need to be at least $100/tonne to be an effective environmental tool.

#2. How does the carbon trading market work?

The EU sets a cap on how much carbon can be emitted by big industrial producers but at the same time gives polluting industries a certain number of free allowances – the right to emit one tonne of CO2 without having to pay for the emissions. Some companies need more allowances then they receive (coal plants). Others have a surplus and these allowances are then traded in the open market, in Europe as part of the European Union Emissions Trading System (ETS) and in the US as part of either the California Cap and Trade Program and the Regional Greenhouse Gas Initiative (RGGI).

#3. What moves carbon prices?

Short answer: emission targets and legislation. Between 2016 and 2018 carbon prices trod water within a tight €3/t range reaching a maximum of €8/t because of relatively few changes in legislation during that period. The big step change happened this summer when the EU committed to cutting its carbon emissions by 55% (previously by 40%) by 2030. In order to make sure that emissions decline each year the EU has put in a mechanism in place by which the amount of free allowances is reduced every year. This combined with the newly set targets that require a larger reduction in emissions means that heavy polluters will need to buy more allowances over the years to come.

Other factors that can nudge prices are gas supply issues. If gas supplies in Europe are tight, as they are this winter, power companies tend to use coal as an alternative raw material and consequently have to buy more allowances to offset their higher CO2 emissions.


#4. How to invest in carbon

The most direct way to trade carbon is via carbon futures. ICE Exchange offers European Emission Allowances futures, UK Allowance (UKA) and California Carbon Allowance futures (CCA), while the CME also offers its newly launched Global Emissions Offset (GEO) futures. An alternative are carbon Exchange Traded Funds such as WisdomTree’s futures-based Carbon ETF (CARP) traded on the London Stock Exchange or the KraneShares Global Carbon ETF (KRBN) and iPathA Series B Carbon ETN (GRN) in the US.

#5. Liquidity and supply

Europe has a well-established and liquid market called the European Union Emissions Trading System (EU ETS), in operation since 2005. It has been the world’s largest carbon trading system until recently and covers allowances from over 10,000 energy-using facilities. Liquidity comes from companies needing carbon allowances such as power companies and industrial plants. For the moment the EU has no intentions to increase the amount of EUAs but a legislative loophole allows a future increase if there is a sustained price rise.

Product Name ISIN Exchange Ticker Listing Currency
WisdomTree Carbon
Hargreaves Lansdown | Interactive Investor | AJ Bell Youinvest | EQi
JE00BP2PWW32 CARP EUR

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This article does not constitute investment advice. Make sure you do your own research or consult a professional advisor.

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