Carbon market volatility due to broader uncertainty, not fundamentals

Oar in Ukraine has many broader and unintended effects on global markets, and a recent casualty has been carbon markets, particularly within the EU. The EU (EUA) allowance market has been particularly volatile, with some investors opting to stay away from any current price action, and technical levels have been triggered and prompted further selling.

Luke Oliver, Managing Director, Head of Strategy at KraneShares, recently explained in a communication to ETF Trends that the carbon market’s price action and underlying causes are rooted in a variety of unrelated uncertainties. fundamentals of the relatively nascent space. Overall, KraneShares believes the market is currently oversold, which was triggered when EUA prices fell 16% on March 1 and fell below €70 ($93.41). This fall has seen engaging technical levels, with technical traders and options hedging pushing the sell further.

The fundamentals in space remain strong, with no signal from the EU that it will reverse any of its climate policies. In addition, there is the anticipation of high natural gas prices, since Russia is one of the main exporters of natural gas to Europe, which could put pressure on industries to switch back to coal for the moment. This would lead to increased emissions, with the prices of carbon allowances increasing in parallel due to growing demand.

“The market regulatory framework has not changed, analysts still see the market as tight on a yearly basis, and there is still a strong 2030 climate target to drive long-term investment,” Oliver explained. “It is also important to note that carbon allowance prices have not been, contrary to popular misconception, materially responsible for the rise in energy prices in Europe.”

A breakdown of the current uncertainties plaguing carbon markets

The uncertainties plaguing carbon markets are driven by questions about how geopolitical tensions and conflict will affect Europe globally, and how climate priorities might be downgraded as geopolitical concerns take precedence. This could mean that countries like Poland and Greece, which have not been in favor of the European Emissions Trading System (EU ETS), could seize the opportunity to better capitalize on their prospects by encouraging less tightening of carbon markets.

It is also possible that a decrease in the supply of natural gas due to current tensions will not lead to an increase in the net emissions induced by the use of coal. It is possible that countries like Germany and others that rely heavily on Russian natural gas will instead find ways to pivot and increase their own natural gas stocks by limiting production from some of the highest-emitting industries.

“For example, Europe could reduce production of gas-intensive metals and fertilizers to preserve supplies. Europe is also extending plans to keep coal-fired power plants (carbon bullish) and nuclear power generation (carbon bearish), the net balance of which the market is still trying to weigh,” Oliver explained.

A final big uncertainty at the moment is whether rising energy prices and other factors such as the potential retreat of industries could lead to a general reduction in economic activity; lower economic productivity naturally equates to reduced emissions and could impact carbon markets.

“Ultimately, a tremendous amount of new information is being digested and the recent selloff has been exacerbated by technical trading. We will continue to monitor the markets and keep abreast of developments, although we reiterate our view that this sale does not appear to be based on fundamental change, but on uncertainty,” Oliver said.

For investors who may have missed the growth of carbon markets globally and in the EU in recent months, the current entry point to invest could provide a good opportunity. “There is potentially an opportunity to enter this market at November 2021 levels for those who missed much of the previous rally,” Oliver said.

KraneShares offers a suite of ETFs with a variety of targeted exposures to global capped and traded carbon allowance markets that invest in carbon credit futures. These funds include KraneShares Global Carbon Strategy ETF (KRBN)which invests in carbon allowance futures globally from the EU, California, RGGI and UK markets, as well as more targeted markets KraneShares European Carbon Allowance Strategy ETF (KEAU).

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


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