Carbon credit ETFs have been brutalized in the past several days as fears over whether Europe can keep its lights on and its vehicles running without Russian fossil fuel exports have sent energy prices soaring.
The four U.S.-listed ETFs that directly hold carbon credits have all lost at least a quarter of their price year-to-date, with the KraneShares European Carbon Allowance ETF (KEUA) falling more than 31% as of market open on Monday.
KEUA is suffering from the double-whammy of Europe’s reliance on Russian oil and gas, and the European Union’s combined carbon trading system that currently aims to reduce the amount of carbon allowances by 2.2% annually. The trading platform is part of the bloc’s plans to reduce its emissions by 55% by the end of the decade and become carbon-neutral by 2050.
Fears have also compounded in Europe over whether the continent will fall into recession due to a lack of power driving down factory orders. In that case, regulated industries won’t need to buy as many carbon allowances, said John Wilson, co-CEO and managing partner of Toronto-based alternative investments firm Ninepoint Partners.
“There's a ton of concern that Europe is going to go into a deep recession here,” he said. “There's talk about an embargo on Russian oil and gas. That's where a big percentage of Germany's energy needs come from, and they're the economic engine of Europe.
High energy prices in Europe prior to Russia’s invasion of Ukraine have also added to uncertainty about the sustainability of carbon allowance prices, with Poland in particular making noise. The Polish parliament passed a resolution last December calling for the European cap-and-trade market to be suspended, and in February demanded the European Commission kick out financial institutions for allegedly bringing undue speculation into the market.
The disruptions in Europe, which accounted for approximately 90% of the global carbon market in 2020, are pushing down prices for credits across the world, including down to carbon markets with smaller geographic range. The KraneShares California Carbon Allowance Strategy ETF (KCCA) tracks the joint carbon credit market in California and Quebec, and has fallen more than 25% year-to-date.
The short-term drops have sent KEUA and KCCA into all-time loss territory, as both of those funds launched last October, but the space is still a long-term gainer. The iPath Series B Carbon ETN (GRN) and the KraneShares Global Carbon Strategy ETF (KRBN) are up 138% and 81%, respectively, over a two-year period as ESG and climate-friendly investing grew in popularity.
Wilson, whose firm operates its own carbon allowance ETFs on the Canadian NEO Exchange, believes the recent sell-off amounts to short-term repositioning, and expects the segment to be worth trillions of dollars over the next several years as world governments keep aiming to slash emissions.
“We're going to have to get off of Russian energy and maybe produce more domestically, but high energy prices are a driving incentive for more renewables,” he said. “I don't think it delays that transition. If anything, it's a necessary function of making that transition happen.”