Volatility spiked in the California carbon market this month on lower auction prices and the regulatory body’s failure to provide further guidance. Though a volatile asset class, the long-term thesis for the market remains strong.
Lower-than-expected auction prices alongside lack of clear updates from CARB likely impacted short-term prices.
“This price action, like the volatility in March, is a characteristic of the market,” Luke Oliver, managing director, head of climate investments, head of strategy at KraneShares explained in the Climate Market Now blog. “This phenomenon is created when the market feels the need to reconcile live and continuous price discovery with the delayed, quarterly published Dutch-style auction from the state.”
The second quarter auction came in 10% lower than Q1, well below expectations. However, the first quarter’s auction settled at $41.76, a record and $3 above Q4 2023. The most recent auction, which settled at $37.02, aligns more closely with 2023 second-half settlements.
Speculation regarding the lower level includes lower aggregate demand at this quarter’s auction. Additionally, a week delay for the auction because of technical problems may have played a role. This delay led to stale bids that didn’t reflect the current spot price. A third potential factor dealt with auction report timing. Reporting of results occurred at a similar time as CARB, California’s market regulator, failed to provide any new meaningful information on proposed changes at its most recent public workshop.
The confluence of disappointing news sent California Carbon Allowance (CCA) prices tumbling 8% before recovering.
“As with last quarter’s options expiry, the lower auction triggered a classic gamma squeeze that exacerbated the volatility,” explained Oliver. A gamma squeeze happens when underlying asset prices rise or fall sharply. This in turn forces options investors to either buy more or sell out of positions as they hedge risk.
“There will likely be some continued volatility ahead of the June 17 option settlement; however, similar to March, we believe this technical driver will be short-lived.”
Ride Short-Term Volatility for Long-Term Fundamentals
Technical trading and other factors drive much of the short-term volatility in the California carbon market. However, the long-term fundamentals remain unchanged. CARB modeled CCA prices of $134 by 2030, with proposed tightening potentially removing 256 million allowances from supply altogether. This removal will drastically reduce supply, resulting in the market shifting into deficit territory beginning as early as next year.
Investors looking to gain exposure should keep in mind “this asset class is a high-conviction, higher-volatility strategy, albeit with low correlations,” according to Oliver. Those investors seeking long-term outcomes with a stomach for volatility along the way should consider the KraneShares California Carbon Allowance Strategy ETF (KCCA ).
KCCA is down 11.19% YTD but is up 5.75% on a price returns basis over the last 12 months as of 06/13/24.
The fund offers targeted exposure to the joint California and Quebec carbon allowance markets. The market is one of the fastest-growing carbon allowance programs worldwide. Its benchmark is the S&P Carbon Credit CCA Index. The CCA includes up to 15% of the cap-and-trade credits from Quebec’s market.
The index tracks the most traded CCA futures contracts. The fund uses a wholly owned subsidiary in the Cayman Islands to prevent investors from needing a K-1 for tax purposes.
KCCA carries an expense ratio of 0.81%.
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