How To Invest In Carbon Credits: A Comprehensive Guide for 2024-25

Through both environmental challenges and regulatory changes, the carbon credit market has proven to be more than just a compliance tool—it has transformed into a potentially attractive investment opportunity. Understanding how to invest in carbon credits is essential for investors looking to capitalize on this growing market. This guide will delve into the key aspects of carbon credit investing, current market trends, the KraneShares Global Carbon Strategy ETF (Ticker: KRBN), the KraneShares California Carbon Allowance Strategy ETF (Ticker: KCCA), and the KraneShares European Carbon Allowance Strategy ETF (Ticker: KEUA).

Understanding the Carbon Credit Market

Carbon credit is a term often used interchangeably between two markets: 1) Carbon cap-and-trade markets and 2) Carbon offsets markets. However, these two markets are distinctly different from a regulatory oversight, market size, and liquidity perspective. 

• Carbon allowances: Mandatory credits issued by governments in cap-and-trade systems. Bought directly at an auction or allocated for free if the entity qualifies. Intended to reduce emissions over time for specified regions/industries through a declining annual cap and additional supply adjustment mechanisms. Market size reached $948 billion in 2023.¹
• Carbon offsets: Voluntary credits bought directly from project developers or brokers/intermediaries. Intended to balance an entity’s carbon footprint by investing in projects that reduce or remove emissions, like building wind turbines or solar farms, supporting methane reduction projects, reforestation, and carbon capture & storage. Market size reached about $4 billion in 2023.²

This guide focuses primarily on carbon allowances, which are traded in compliance markets.

Key features of carbon credit markets include:

• Cap-and-trade systems set emissions limits for specific industries, including oil and gas production, transportation, electricity distribution utilities, and large industrial facilities.
• Allowances can be traded between companies, creating a market-based approach to emission reduction
• The cap typically decreases over time, driving up the cost of emissions and the price of credits

Why Invest in Carbon Credits?

Carbon credit investments offer several potential advantages:

• Environmental impact: Supporting the transition to a low-carbon economy
• Portfolio diversification: Low correlation with traditional asset classes*³
• Potential for growth: As emission caps tighten, allowance prices may increase⁴
• Potential inflation hedge: Carbon prices have shown resilience during inflationary periods because market structure helps drive carbon pricing⁵
• Exposure to climate policy: Benefit from increasing global focus on emissions reduction⁶
• Proven track record: Cap-and-trade effectively solved the acid rain crisis of the ’80s, with similar market principles being applied globally with carbon emissions⁷

Diversification does not ensure a profit or guarantee against a loss.

*Top four carbon allowance markets (weighted by volume) versus major asset classes, including US equities, bonds, commodities, real estate, gold, and oil.

Key Trends Shaping the Carbon Credit Market in 2024

• Expanding market coverage: More sectors and regions are being included in cap-and-trade systems
• Increasing prices: As caps tighten, allowance prices have generally trended upward⁴
• Growing liquidity: Trading volumes in carbon futures markets reached $754 billion in 2023⁸
• Policy developments: Ongoing refinements to existing systems and potential new markets
• Corporate net-zero commitments: Increasing demand for both allowances and offsets
• Technological advancements: Improved monitoring and verification of emissions and offsets

Future Outlook

The carbon credit market’s future looks promising, supported by several factors:

• Global climate commitments: Increasing government action to reduce emissions
• Market maturation: Growing sophistication and liquidity in trading systems
• Investor interest: Rising demand for climate-related financial products
• Potential new markets: Expansion of cap-and-trade systems to new regions and sectors, with new ETS emerging in Latin America and the Caribbean⁹
• Harmonization efforts: Possible linking of different carbon markets over time

How to Invest in Carbon Credits

KRBN is benchmarked to the S&P Global Carbon Credit Index, which offers broad coverage of cap-and-trade carbon allowances by tracking the most traded carbon credit futures contracts. Key features of KRBN:

1. Broad market exposure: Includes European Union Allowances (EUA), California Carbon Allowances (CCA), the Regional Greenhouse Gas Initiative (RGGI), and United Kingdom Allowances (UKA)
2. Liquidity: Utilizes futures contracts for efficient trading
3. Diversification: Low correlation with traditional asset classes

KCCA provides targeted exposure to the California Cap-and-Trade Carbon Allowance Program. It is one of the fastest-growing carbon allowance markets globally, and in 2021, CCA carbon allowance futures traded around $1.5 billion per month.¹⁰

KEUA offers focused exposure to the European Union Emissions Trading System (EU ETS), the world’s largest carbon market by trading volume.

KCCA and KEUA allow investors to tailor their exposure to specific regional carbon markets, complementing KRBN’s broader approach. Each fund utilizes a similar strategy of investing in carbon allowance futures contracts, providing efficient access to its respective markets.

Carbon Market Structure

Understanding the structure of carbon markets is crucial for investors: Emission Trading Systems (ETS)

Also known as cap-and-trade programs, ETS set limits on emissions and allow trading of allowances. Key participants include:

• Emitters: Companies required to comply with emission limits
• Capital market participants: Investors and financial institutions providing liquidity

Market Coverage

Different ETS cover various sectors and emission scopes:

• EU and UK ETS: Power generation, manufacturing, aviation
• California: Transport, buildings, industry, power generation
• RGGI: Power generation in Northeastern US states

Conclusion

Investing in carbon credits offers a unique opportunity to support climate action while potentially benefiting from the growth. By understanding the dynamics of carbon markets and utilizing tools like the KRBN ETF, investors can gain exposure to this important aspect of the global transition to a low-carbon economy.

For more detailed information on carbon markets, credits, and the KraneShares carbon ETF suite, please download our latest report and read our carbon FAQ: California Carbon: New Supply Clarity Drives Markets and What are Carbon Credits? Carbon ETF FAQ, or subscribe to our blog at https://climatemarketnow.com/.

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For KRBN standard performance, top 10 holdings, risks, and other fund information, please click here.

For KEUA standard performance, top 10 holdings, risks, and other fund information, please click here.

For KCCA standard performance, top 10 holdings, risks, and other fund information, please click here.

Citations:

1. Data from Reuters as of 7/12/2024.
2. Data from Statista as of 7/4/2024.
3. Data from Bloomberg and S&P Indices as of 8/31/2014-6/30/2024. *Carbon allowances: top four carbon allowance markets (weighted by volume) versus major asset classes, including US equities, bonds, commodities, real estate, gold, and oil.
4. Carbon Offset Guide, “Allowances,” retrieved 8/31/2024.
5. Data from Bloomberg and KraneShares analysis as of 8/31/2024.
6. Intergovernmental Panel on Climate Change, “Urgent climate action can secure a liveable future for all,” as of 3/20/2023. Retrieved 8/31/2024.
7. US Environmental Protection Agency, “Acid Rain Program,” retrieved 8/31/2024.
8. Data from Bloomberg as of 12/31/2023.
9. Data from Green Finance for Latin America and the Caribbean, “Carbon Markets,” retrieved 8/31/2024.
10. Data from Bloomberg as of 12/31/2021. Retrieved 8/31/2024.