Climate Finance | August 17, 2021

Forget crypto: Here’s how to play the rising price of carbon

David Bank
ImpactAlpha Editor

David Bank

ImpactAlpha, August 17, 2021 – Rising demand. Shrinking supply. Higher prices. 

Carbon markets in Europe, California and elsewhere are finally starting to work as intended to raise the cost of emitting greenhouse gases that cause global warming for power plants, refineries and other major polluters. 

“Suddenly we’re at a point where you hit that inflection where supply and demand flips,” venture capital and private equity investor Edwin Datson says on the latest Agents of Impact podcast. “People start suddenly realizing not only will there be scarcity this year, but that scarcity will get worse and worse and worse. And then that really drives the prices up.”

The global carbon market grew 20% last year to reach $272 billion, according to Refinitiv. Some analysts say it could be worth 10 times that by the end of the decade. The global market for crypto currencies is estimated to be about $2 trillion.

On the podcast, Datson breaks down recent developments that are making carbon a hot commodity on global markets. The price of carbon will be key to climate policy at this fall’s COP 26 climate summit in Glasgow, and for years to come. Still to be proven: whether rising prices actually cut real-world carbon emissions.

Rising prices

Corporations and outside investors are starting to stockpile carbon as prices curve upward. 

Carbon markets were seen as boring backwaters until 2018, when regulators in Europe began to ratchet down allowances that major emitters, including aviation and mining, had been granted to ease the emergence of the European Union’s emissions trading scheme, the world’s largest. Since then, carbon prices that had hovered at about €5 per ton have reached nearly €60 per ton. Some analysts predict the price to top €100 per ton before year-end.

That is making cost-effective operational changes and carbon-mitigation projects that were considered uneconomical only a short time ago. 

“Suddenly those projects make an awful lot of sense from a net-present-value point of view,” he says. “So if the carbon pricing curve is looking like it’s accelerating upwards, then all of these investments to reduce or abate their CO2 will get greenlit today, not in three or four years.”

California’s cap-and-trade market has followed a similar trajectory. Generous free allowances for major emitters, abetted by active lobbying campaigns, kept prices low since the program was launched in 2013. But as in Europe, prices are ticking up as regulators ratchet down the allowances. 

“Most people are predicting that sort of mid-next year, that supply-demand thing will flip,” Datson says. “Ahead of that people are starting to realize that now is the time to start stockpiling because these allowances are good forever, basically. So you’ve suddenly seen the price go from sort of $14 at the of last year to sort of $22-ish today.”

Rising prices in so-called “compliance,” or regulated, markets are being matched by increases in voluntary carbon credits, sometimes called offsets. The main driver: increasingly ambitious corporate pledges to reach “net zero” carbon emissions, generally by 2050 but sometimes as soon as 2040 or even 2030.

“Those prices are going crazy,” Datson says. While still lower than the compliance markets, prices on some voluntary carbon markets have been increasing as much as 10% per month. 

That trend has encouraged the new crop of “soil carbon” suppliers, who are working with farmers to implement agricultural techniques that reduce carbon emissions, such as no-till agriculture and the use of cover crops. Forest conservation schemes attempt to quantify the tons of carbons stored in trees that might otherwise be cut or burned. Payments for carbon credits are helping finance efforts to preserve mangrove forests, which also are key to coastal protection and biodiversity (see, “Conservation of mangrove forests could get a boost from carbon credits”)

Critics have questioned the quality of some voluntary offsets – that is, whether they really do remove carbon or store it effectively. “Corporates have been burned once on this already and I think they’re getting much better in terms of understanding what true offset quality is and what the true price of that is likely to be,” Datson says. 

Valuing carbon

Datson, who heads climate tech investing for San Francisco-based CRCM Ventures, began exploring carbon-market strategies as an outgrowth of his venture capital investing in technology companies promising to reduce or remove carbon.

“If you’re trying to put a value on those companies, you need to know what the value of CO2 is. And the thing that was crazy to me was that there isn’t one. There absolutely should be one but at the moment there isn’t one.”

Over time, the global nature of carbon will drive convergence of the fragmented market. In the meantime, Datson and other fund managers spot an opportunity to buy baskets of allowances and credits in a variety of markets to be able to mix and match them to meet the needs of various customers.

“We think that there’s a huge opportunity to acquire a diversified portfolio of these things around the world,” he says in the podcast. “And as more of these markets become better developed as financial markets, both on the voluntary side and the compliance side, I think that will accelerate the entrance of new players that will create more liquidity that will create more visibility, that will create more players, and there will be significant price appreciation. That’s what we’re trying to do.”

China has taken the first steps to establish its own carbon market, which will quickly become the world’s largest. Critics have said that low initial prices – under $8 per ton – are not enough to drive changes in behavior in the world’s largest carbon-emitting nation. But the low prices are a buying opportunity for investors who can take the long view and wait for the shift in supply and demand that have propelled prices elsewhere.

Even investing in basic carbon exchange-traded funds like KraneShares Global Carbon ETF (KRBN) or iPath Series B Carbon ETN (GRN) have year-to-date returns of nearly 50% and more than 70%, respectively.

“We think you can do better than that, or as good as that is, by also investing in high-quality offsets and in schemes which are at an earlier stage of their development,” Datson says. New emission-trading schemes almost always launch “long” to keep prices low and prevent economic disruptions, before flipping to “short” as allowances are reduced and demand increases. 

“So I think you can invest early in the less-liquid scheme before the futures markets are well developed, before the liquidity is there, and get outsized return for taking that lack of liquidity.”

Thanks to Solutions Journalism Network for supporting ImpactAlpha’s deep dive into carbon pricing and carbon markets.

Catch up on all of ImpactAlpha’s podcasts, including our weekly Impact Briefing.