An Advisor's Guide to the European Carbon Market with KraneShares

An Advisor’s Guide to the European Carbon Market with KraneShares

Europe’s energy crisis has largely eased for now and a decision is expected to be finalized within the next month on the RePowerEU initiative to wean Europe from dependence on Russian fossil fuels. Luke Oliver, Managing Director, Head of Climate Investments and Head of Strategy at KraneShares, offered advice mid-month in a recent article on what all the changes mean for the EU carbon trading market and recently reviewed the performance of EU quotas.

Winter stocks for the EU are currently at around 95% of capacity in mid-November after Europe implemented policies this year that led to reduced seasonal demand, diversification sources of energy supply and the creation of minimum standards for storage inventory obligations. Gas prices that were at historic lows over the summer then fell as the crisis subsided, down nearly two-thirds from their summer highs.

Russia’s invasion of Ukraine earlier this year and its ongoing war continue to have long-term effects on the macroeconomic environment, with inflationary pressures affecting equities and sparking recession fears and a reduction in industrial production. Carbon allowances are relatively uncorrelated, but have been subject this year to macroeconomic trends of volatility and uncertainty in global markets.

“However, equity indices are currently holding up better than expected, while gross domestic product (GDP) remains broadly positive. This sentiment was reflected in European equity markets, with the EuroStoxx50 rising around 16% over the past six weeks.“, Oliver explained. “Policy reform and market-tightening measures also present strong structural support for the future of the [EUA] program and its ability to withstand a mixed macro environment.

Performance of the EU carbon market and potential impacts of RePowerEU

EU (EUA) carbon allowances have been moving around the €80 ($83) support/resistance band for much of the year, either bumping into it and pulling back recently in the middle €70, i.e. fluctuating between €80 and €90 ($83). -93) from April to September of this year.

“This pattern of price action may continue until new positions are re-established at higher levels as the market absorbs some recent positive signals and establishes a clear view of key regulatory issues currently under discussion” , Oliver wrote.

The RePowerEU plan presented by the European Commission earlier this year aims to establish the framework for eliminating dependence on Russian fossil fuels. At the height of Europe’s energy crisis, proposals included selling EUAs from the Market Stability Reserve (MSR) to help fund the transition, a move that could undermine the validity of the MSR and reduce US prices. The MSR was created to prevent price volatility in the allowance market through its ability to release or hold allowances.

“At this month’s plenary session, Parliament is expected to finalize its position, which will most likely be to preload EUAs from future auctions, a materially more constructive solution than tapping into the MSR. Meanwhile, the EU Council has proposed a hybrid approach of 25% from frontloading and 75% from the Innovation Fund,” explained Oliver.

Image source: KraneShares

Frontloaded EUAs would be carried over from scheduled auctions between 2027 and 2030, increasing short-term funding capabilities without unnecessarily bloating the system in the long term. According to the voted resolution, EUA prices could diverge by up to 23% according to Bloomberg New Energy Finance.

Investment opportunities in the EU carbon market with KEUA

“With carbon analysts at the recent Carbon Forward conference in London publishing a projected median price of €80 ($83) for EUAs by the end of 2022 and clarity returning to the dynamics of supply and demand, we are closely watching the break above this level,” Olivier said.

The KraneShares European Carbon Allowance ETF (KUA) offers targeted exposure to the EU carbon allowance market and is actively managed.

The fund’s benchmark is the IHS Markit Carbon EUA Index, an index that tracks the most traded EUA futures, a market that is the oldest and most liquid for carbon allowances. The market currently offers coverage for around 40% of all EU issues, including 27 Member States and Norway, Iceland and Liechtenstein.

KEUA has an expense ratio of 0.78%.

For more news, insights and strategy, visit the Climate Insights channel.

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