Carbon markets, both voluntary and compliance, experienced strong growth in 2021, setting the stage for continued potential growth in 2022. The European Union, the biggest global submarket, experienced the strongest gains last year, but all of the prominent compliance markets exhibited significant growth. Luke Oliver, head of strategy for KraneShares, discusses the growth of the sector as whole in 2021 as well as individual factors in a recent white paper.
The worldwide carbon index, the IHS Markit Global Carbon Index, that tracks the major global carbon markets futures and offers an easy-to-understand data set across different-sized markets, had a 108% return in 2021. The internal price of carbon between the markets in the index more than doubled last year, rising from $24.78 in January to $51.45 at the end of December.
Image source: KraneShares
These individual markets all exhibited extremely strong growth; the outperforming European carbon allowances (EUA) futures gained 138%, currently trading above a $90 equivalent, while the smallest market, the Regional Greenhouse Gas Initiative (RGGI), had 68% returns and currently trades around $14.00.
Factors That Contributed to Growth
The European Commission announced their “Fit for 55” package mid-year, and it was one of the most pivotal moments for carbon markets in 2021 and will shape the future of the EUA. The major points from the package include keeping the market stability reserve (MSR) purchases at 24% until 2030, increasing the linear reduction factor (pertaining to supply) from 2.2% to 4.2%, and also phasing out all free allocations and pivoting to 100% auction by 2027.
The 26th Conference of the Parties (CO26), the major climate change summit, was completed in November, and the Glasgow Climate Pact was enacted there. The summit saw more than 150 countries voluntarily committing to emission cuts as well as targeting greenhouse gases released from methane, coal, deforestation, and transport. One of the biggest things to come out of the summit was an agreement on creating an international carbon credit trading market under Article 6 of the Paris Agreement for public and private industries, as well as countries.
Natural gas was in high demand in 2021 and was one of a handful of markets that outperformed the carbon market last year. Natural gas is often seen as an easy route to emissions reductions, as it releases half of the carbon dioxide of coal when used as a fuel source.
The increasing natural gas prices are unrelated to carbon pricing, but increasing demand can help support carbon prices; natural gas prices soared in the European Union, rising 300% last year. Oliver theorizes that these drastically higher prices can promote innovation within the sector, but that ultimately a stabilization of natural gas prices would promote further emission reductions.
Last year also saw the introduction of a national carbon emissions trading market in China, one that is well-positioned to become the largest global carbon market and is expected to expand in 2022. South Korea has also allowed more international access to its longer-established market, marking a trend of growth within the global carbon market, as well as increasing diversification.
“2021 was a defining year for carbon markets as an asset class, making headlines in terms of both performance and climate impact. While the voluntary offset market made huge strides, it was dwarfed by the much larger, more liquid segment of the ecosystem – the compliance market,” writes Oliver. “Further, the year was full of huge developments as well as challenges that made the space increasingly compelling and diverse with new markets entering and a renewed international focus."
The KraneShares Global Carbon ETF (KRBN ) offers a first-of-its-kind take on carbon credits trading and is in a position to capture the rise in carbon allowance prices as emissions limits become more stringent.
KRBN tracks the IHS Markit Global Carbon Index, which follows the most liquid carbon credit futures contracts in the world. This includes contracts from the European Union Allowances (EUA), California Carbon Allowances (CCA), and Regional Greenhouse Gas Initiative (RGGI) markets.
KRBN carries an expense ratio of 0.78% and has $1.7 billion in net assets.
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