By now, you may have heard of the incipient bull market in commodities. Oil has regained its pre-pandemic highs, lumber has more than doubled in price from last year, and precious metals like platinum and copper are multiplying investors’ fortunes manyfold.
But there’s another, more obscure commodity that is at the beginning of a bull market that could dwarf all of the above: carbon credits.
The price of a one-metric-ton carbon dioxide emission permit within the EU’s Emissions Trading System (ETS) has more than doubled from its pre-pandemic levels in the last few weeks.
This rally could be a fortune-maker for energy and environmental investors. But before we discuss how and why to invest in these unusual assets, we should start by explaining what carbon credits actually are and why the world’s largest market for carbon credits is going gangbusters right now...
What Are Carbon Credits?
In the simplest possible terms, a carbon credit is a tradeable permit that gives its holder the right to emit one metric ton of carbon dioxide or a chemically equivalent amount of a different greenhouse gas like methane.
Carbon credits are usually rolled out as part of a cap-and-trade system (also known as an emissions trading system, or ETS).
Under such systems, a government allocates or sells a limited number of carbon credits to private companies, effectively creating a “cap” on total emissions. As long as they comply with the cap, those companies are free to buy or sell those credits amongst themselves — or redeem them for emissions rights — as they see fit.
The EU ETS is by far the largest cap-and-trade system in the world, accounting for more than 90% of the global carbon credit market and sporting a market capitalization of more than $250 billion.
As you can see above, it was rolled out in three distinct phases of credits starting in the early 2000s, with each phase (including the current one) seeing substantial credit price volatility.
But as you may have noticed, Phase III bucks a trend set by Phase I and Phase II. Those first couple of phases crashed in price within a few years, but the third one has recovered from its mid-2010s selloff and is now embarking on a new bull run.
So what changed?
Why Are European Carbon Credits Experiencing An Historic Rally?
In short, you can thank a combination of aggressive environmental policy and market momentum for the current carbon credit bull market.
In a May 25 meeting of the European Council, the bloc announced plans to cut its carbon emissions by 55% by 2030 and by 100% (to net-zero) by 2050. As you can see below, that would involve a pretty heavy reduction in the supply of EU ETS carbon credits.
This supply-side pressure helped push the price of EU credits past €50 in early May, a key milestone many analysts were waiting for. Fund inflows have quickened sharply since that time.
The EU’s faith in its own ETS is also being buoyed by similar proposals elsewhere. In the U.S., the Business Roundtable and the Commodity Futures Trading Commission (CFTC) have both called for the U.S. to adopt an EU ETS-style national cap-and-trade system.
In sum, a combination of fundamental and technical factors are pushing EU carbon credits into a dizzying bull market that doesn’t seem to be anywhere near its end.
But how do you actually invest in the things?
How to Profit From The Carbon Credit Rally
EU ETS credits aren’t exactly easy for an individual retail investor to buy. In order to buy credits, you need to register an account with the EU ETS, a bureaucratic and paperwork-intensive process.
Plus, individuals have no reason to purchase carbon credits; they’re intended as a corporate compliance system. You’re better off investing in carbon credits indirectly through something like an exchange-traded fund (ETF).
And as luck would have it, there are two such carbon credit-related funds on the market today!
The iPath Series B Carbon ETN (NYSE: GRN) is a pure play on carbon credits. The note tracks the Barclays Global Carbon II TR USD Index, the main benchmark of the world’s carbon credit markets.
The iShares MSCI ACWI Low Carbon Target ETF (NYSE: CRBN), on the other hand, tracks a basket of large- and mid-cap stocks that own large numbers of credits.
As you can see below, both funds have rocketed upward in the last year. CRBN has beaten the S&P 500... but GRN has trounced it.
Energy and Captial’s Carbon Credits Watchlist: iPath Series B Carbon ETN (NYSE: GRN), iShares MSCI ACWI Low Carbon Target ETF (NYSE: CRBN)
Both funds have a relatively low correlation with other assets, making them great portfolio diversifiers.
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