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Capturing carbon

  • Analysis suggests the price of carbon emissions is set to rise
  • The absence of a London-listed carbon-tracking fund is glaring

There is something about exchange traded funds (ETFs). It doesn’t matter how many there are, there is never the one you want. The new ETF tracker tool from Financial Times tells me European investors can pick from 2,456 ETFs, which compares nicely with, say, the choice of 613 stocks in the FTSE All-Share index. But is there a single ETF that tracks changes in the price of carbon? I should be so lucky.

This is a glaring omission, especially for product providers who offer lots of commodity trackers; glaring because putting a price on carbon is supposed to be vital in preventing average temperatures on Planet Earth from reaching dangerously high levels. Sure, that’s a gross oversimplification, but it accords with conventional wisdom on global warming – the more that global emissions of CO2 are restricted, the less that average temperatures will rise above pre-industrial levels.

The challenge therefore becomes how best to do this, to which there are two solutions – tax carbon emissions or use a combination of carrot and stick (‘cap and trade’, as it is known). Taxing is efficient, already used extensively (though surreptitiously) and unpopular. Cap and trade’s combination of compulsion and incentive provides a system that allows polluters to pollute (if you think of CO2 as pollution, that is), but gives them an incentive to be good.

As such, it is the tool of choice; so much so that China is in the process of rolling out the daddy of all cap-and-trade systems. It starts with the power-generating sector and could end up with airlines; at least, airline operators have been told to submit emissions data to one of China’s eight regionalised trial schemes. Couple this with the cascade of nations eager to put zero-emissions targets into law and it is easy to imagine that a licence to emit a given amount of carbon will become an increasingly valuable commodity.

Not that it has always been the case. So far, it is fair to say cap and trade has not lived up to its billing. Over-generous allowances and underwhelming demand mean the carbon price has not matched the minimum levels supposedly needed to keep emissions at a level consistent with 2016’s Paris Agreement for tackling global warming. That required the carbon price to be at least $40 per tonne by 2020, whereas it hit a maximum of $37 in the period 2008 to 2020 and averaged just $14.

That was then. This is now and a new decade at the end of which, according to the Paris Agreement, the carbon price must be at least $50 and preferably closer to $100. That offers decent upside. The price is currently $40.7, so it would have to rise by 2.3 per cent a year to hit $50 by 2030. Much juicier, to get to $100, the price would have to rise by 10.5 per cent a year.

And the signs are good. Naturally enough, Covid-19’s effects have delayed implementing some measures to limit CO2 emissions, while airlines have challenged their offsetting obligations. Even so, volumes traded are well up and the carbon price is on a roll. The IHS Markit Global Carbon index, based on the weighted average of the world’s five major carbon-trading schemes, has generated a 378 per cent return in the past four years and a 39 per cent return in the past 12 months.

In addition, according to KFA Funds, a US-based investment manager, carbon allowances are good to include in an investment portfolio because their price has a low correlation with the major asset classes that usually go into portfolios – equities, bonds and property. True, there is only limited data with which to make the comparison and KFA might be biased because it has recently launched on the New York Stock Exchange the sort of ETF that London needs – KFA Global Carbon (US:KRBN), which aims to beat the IHS Markit carbon index.

Quite why the fund manager should aim to be beat the carbon index while being long of carbon isn’t clear. For retail investors in the UK it probably does not matter because they will be hard-pushed to buy shares in the fund. UK brokers won’t deal in the KFA fund for retail investors because it has not met UK financial regulations, no matter that it ticks the boxes for US regulations.

Meanwhile, the sole UK-compliant London-listed ETF that tracked carbon prices, Wisdom Tree Carbon, was liquidated last summer. That move was forced when the UK trading arm of Royal Dutch Shell (RDSB) ceased to act as the counter party for various Wisdom Tree commodity ETFs. Since then, so far as I know, nothing; although I would be happy to be proved wrong – retail investors badly need an easy way to capture carbon.