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Alternative Market Briefing

As world carbon markets expand, traders find new opportunities

Tuesday, September 29, 2020

Bailey McCann, Opalesque New York for New Managers:

2020 has been a challenging year for carbon investors. As covid-19 expanded worldwide shutting down global travel and economies, emissions plummeted and along with it the price of carbon. In a normal year, carbon prices remain relatively high because there is a limited budget, and certain industries like airlines need carbon offsets to do business. Now as economies slowly open back up, emissions are once again on the rise increasing the demand for carbon. One carbon trader argues the price could go even higher as the pandemic shuffles policy priorities.

According to data from Fitch, demand for carbon offsets is likely to outstrip supply by 2025 as climate policies tighten. Free trading of carbon offsets under a global scheme could cut costs of the Paris Agreement by up to 33% by 2030, or achieve a 50% increase in abatement for equivalent costs by directing mitigation towards the lowest-cost options. However, governments have struggled to agree on issues, such as the carryover of past credits, accounting treatment, and measures to ensure the additionality of overall emissions reduction. Now, with coronavirus influencing policy decisions on a range of issues, policymakers may get more aggressive on carbon policy.

"What we're seeing is a reckoning," says Michael Azlen, founder and CEO of Carbon Cap Management, a hedge fund focused on trading the carbon market. "There's a new recognition of the impact of pandemics, of climate change, and the systemic risks created by these events. We think the ambition of policymakers has increased during this time because they understand that they have to act now to address these challenges. That could mean new opportunities for carbon as an asset class."

Indeed, the EU voted this month to make ships pay for the pollution they cause when they carry cargo to and from Europe. While the details are still being ironed out, the decision means that shipping could be included in the EU Emissions Trading System. The trading system sets a cap on the total quantity of emissions and allows the market to determine the price for tradable emissions allowances. Before this vote, industries like utilities and airlines were already vying for carbon credits within this cap. If shippers join the market, there will be less carbon to go around which will increase its value to investors.

In addition to adding new industries to emissions systems, some countries are in the process of creating or expanding their carbon markets, which will give investors new places to put their money. In April, South Korea announced that it would be opening its carbon market to financial firms and institutions to participate in the secondary market and trade allowances or converted carbon offset units on the Korea Exchange (KRX). China is also working on the launch of what will be the world's largest Carbon market. Rules governing the allocation plan are still being debated, but Azlen says that the developments in both Korea and China are significant for investors.

"The addition of China to the carbon market will add almost 10% to the total amount of planetary emissions that will be covered by a carbon price of some of some type," Azlen says.

The US election could also impact carbon markets domestically. New Jersey, Pennsylvania, and Virginia have all recently passed legislation that would see them join a regional carbon market. According to Azlen, these additions strengthen his overall view of the US market.

As the carbon market expands, pricing is likely to become a consistent policy priority for regulators. Right now, the carbon budget decreases each year, which shores up the value of carbon credits. If policymakers turn their ambition into action Azlen suggests that the next 1-3 years could be a high value period for carbon investing. "Carbon is still an emerging asset class, but it's one that is becoming increasingly important as the world grapples with how to respond to climate change and systemic risk. When you have a limited market with forced buyers, that creates a unique opportunity."

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