The Complexity of the Carbon Market That Hinders Its Growth
Carbon trading as a market has a problem! Despite its good intentions, the market of trading carbon credits is so fragmented (by different standards) and complex that many traders who are active in other types of commodity markets or the stock market stay away from trying their chances at profiting from carbon. Differences in carbon standards, regional markets, types of offset projects, and a host of other offset price determinants create an environment where there is no unified price for the main unit of carbon – the metric ton of CO2 equivalent (tCO2e). As a result, the total size of the voluntary carbon trading market is only around $2 billion, though estimates vary wildly by source.
This figure looks miniscule in comparison to the trillions flowing through the commodities market or the stock market every year. Many key commodity segments, e.g., energy commodities or some key agricultural commodities, also have their annual turnovers measured in trillions or at least hundreds of billions.
Given the importance of climate action, the fact that the voluntary carbon trading market has been around for good two decades, and the level of interest shown by governments, non-profits, and businesses, the size of the voluntary market could have been much larger. Besides the fragmentation and complexity of the market, another factor contributing to the lack of growth is the very high horse some in the industry prefer to ride. There is a belief in some sectors of the market that carbon is not merely an ordinary commodity to be traded in a standardized way. Such a belief further slows down the market’s development.
We would argue, however, that the voluntary carbon market, and the climate action associated with it, could benefit from more standardisation. With more standardised pricing and products, many more traders and investors would flock to the market, livening it up and significantly boosting its turnover. The stock market only benefited from the expansion of its availability to the masses of rank-and-file investors. There is no reason why it shouldn’t happen with the voluntary carbon market.
A Quick Start Option for Carbon Trading
Many commodity and stock traders would like to get exposure to carbon trading. Since this is still a relatively new market, many of the traders rightfully reason that there could be some unique opportunities in the market unavailable in the more established commodity and stock markets. However, as noted above, given the fragmentation and complexity of the market, many potential traders are staying away for now.
What can you do if you want to explore the market of trading carbon but don’t feel expert enough in the various carbon standards and markets? The closest thing to a quick start in this market involves staying with the boundaries of the stock market and investing in products tracking major carbon indices.
There are not many of those products around yet. The world’s first index providing a weighted-average computed price of carbon is the IHS Markit Global Carbon Index. The index is based on carbon futures available on four highly liquid regional markets - European Union Allowance (EUA), UK Allowance (UKA), California Carbon Allowance (CCA), Regional Greenhouse Gas Initiative (RGGI). The index issuer, IHS Markit, last year merged with S&P Global, a name very well known in the niche of market indices.
ETFs tracking this index are still few and far between. As of the time of writing, the KraneShares Global Carbon ETF (KRBN) tracks the Global Carbon Index by IHS Markit. According to the ETF issuer, the fund has achieved a nearly 150% NAV since its inception in August 2020 and a 30% NAV over the last 6 months.
Investing in an ETF based on a defined carbon price tracking index has enormous advantages for traders who are not yet experts in this highly specialized and still small market. Firstly, you remain within the boundaries of the familiar stock market. Secondly, you now have a defined price of carbon, even if based on some proprietary averaging methodology, that you can track, analyse, and apply your strategies and simulations against. It turns out that investing in carbon trading and the future of our planet needn’t be as complicated as the carbon market regulators try to make it.