The price of carbon emission allowances has risen significantly since the start of this year. As of 09 September, the price of carbon is up over 90% year to date (in EUR terms). Carbon’s rally has dwarfed that of broad commodities, an asset class otherwise on a strong run this year (see figure below).
Figure 1: Carbon’s rally received an additional boost from natural gas shortages in August
Source: WisdomTree, Bloomberg. Year to date data as of 09 September 2021. Carbon is represented by the Solactive Carbon Emission Allowances Rolling Futures Total Return Index. All data is shown in EUR.
Historical performance is not an indication of future performance and any investments may go down in value.
So, what might be behind the rally?
An asset class built on a structural need
The European Union Emissions Trading Scheme (EU ETS) is the world’s biggest carbon market and the foundation of the European Union’s (EU) policy to mitigate climate change and reduce greenhouse gas emissions. The scheme is intended to support the EU in achieving carbon neutrality in the region by 2050.
The EU ETS limits the amount of greenhouse gases that can be emitted by companies each year. Companies must hold enough allowances to cover their emissions and secure these allowances from a limited supply issued each year. Price increases in carbon emission allowances make it more expensive for companies to cover their carbon footprint and incentivise them to invest in pollution abatement technology.
As an asset class, Carbon is an investment in European Union’s Carbon Emission Allowances, a liquid futures market. With the European Union looking to increasingly reduce emissions, supply is structurally expected to remain tight.
More momentum from Hurricane Ida
According to the US Energy Information Administration (EIA), more than 90% of natural gas production in the Federal Offshore Gulf of Mexico (GOM) was offline in late August following Hurricane Ida. GOM production of natural gas averaged 1.9bn cubic feet per day (Bcf/d) in August, down 0.4 Bcf/d from July. The EIA expects production to gradually come back online over the month of September.
But how does the shortage of US gas supply relate to carbon prices? The first-order effect is on the European gas market. According to the European Commission, Europe’s gas market has been tight this year due to low domestic production. There has, therefore, been greater reliance on liquified natural gas (LNG) imports. With the US being one of the key suppliers of natural gas to Europe, tightness in US gas supply thus has a bearing on Europe.
This tightness in the gas market, in turn, incentivises more coal-fired electricity production in Europe, triggering more demand for carbon emission allowances. Given this has happened in August, a time when auction supply is already limited, the boost to prices has been augmented further.
As winter approaches, tightness in Europe’s gas supply may continue to have a bearing on carbon prices as electricity producers may be forced to keep turning to coal. Coal is a relatively cheap fuel for power generation but has a relatively high carbon footprint and therefore requires more emission allowances.
Originally Posted on September 10, 2021 – Carbon Gains Additional Momentum from Hurricane Ida
Disclosure: WisdomTree Europe
This material is prepared by WisdomTree and its affiliates and is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date of production and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by WisdomTree, nor any affiliate, nor any of their officers, employees or agents. Reliance upon information in this material is at the sole discretion of the reader. Past performance is not a reliable indicator of future performance.
Please click here for our full disclaimer.
Jurisdictions in the European Economic Area (“EEA”): This content has been provided by WisdomTree Ireland Limited, which is authorised and regulated by the Central Bank of Ireland.
Jurisdictions outside of the EEA: This content has been provided by WisdomTree UK Limited, which is authorised and regulated by the United Kingdom Financial Conduct Authority.
Disclosure: Interactive Brokers
Information posted on IBKR Traders’ Insight that is provided by third-parties and not by Interactive Brokers does NOT constitute a recommendation by Interactive Brokers that you should contract for the services of that third party. Third-party participants who contribute to IBKR Traders’ Insight are independent of Interactive Brokers and Interactive Brokers does not make any representations or warranties concerning the services offered, their past or future performance, or the accuracy of the information provided by the third party. Past performance is no guarantee of future results.
This material is from WisdomTree Europe and is being posted with permission from WisdomTree Europe. The views expressed in this material are solely those of the author and/or WisdomTree Europe and IBKR is not endorsing or recommending any investment or trading discussed in the material. This material is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation to buy, sell or hold such security. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.
In accordance with EU regulation: The statements in this document shall not be considered as an objective or independent explanation of the matters. Please note that this document (a) has not been prepared in accordance with legal requirements designed to promote the independence of investment research, and (b) is not subject to any prohibition on dealing ahead of the dissemination or publication of investment research.
Disclosure: Futures Trading
Futures are not suitable for all investors. The amount you may lose may be greater than your initial investment. Before trading futures, please read the CFTC Risk Disclosure. A copy and additional information are available at ibkr.com.