Give your portfolio some credit
Carbon credits are not just for corporations seeking net zero, they’re a potential investment to decarbonize portfolios
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Is your investment portfolio getting the credits it deserves?
The credit in question here isn’t about investing in short-term loans.
Rather, we’re talking carbon credits, which are increasingly viewed as the new currency of growing efforts to mitigate climate change.
While Canada has put a price on pollution with the carbon tax, other jurisdictions — and even Canadian provinces like Quebec — have engaged in cap-and-trade regimes for industry that have created compliance carbon credit markets, in which these offsets are bought and sold as commodities on futures exchanges.
Today these non-voluntary carbon markets — which include California’s and Quebec’s, another for northeastern U.S. states, one for the United Kingdom and, the world’s largest, the European Union’s — are valued at about $1 trillion.
“It’s a market-based approach driven by regulation that says, ‘there are huge economic costs to the carbon you’re emitting that we never forced you to consider before, and now we’re forcing you to consider those emissions and reduce them,’” says John Wilson, managing partner of Ninepoint Partners.
The Canadian asset manager runs the Ninepoint Carbon Credit exchange-traded fund (ETF) — also offered as a mutual fund — that provides exposure to all these non-voluntary credit markets.
It’s one of many funds that have launched in recent years investing in compliance credits seeking to profit from growing demand. Fuelling demand are companies operating in these jurisdictions. They can either earn credits for climate-friendly projects, helping them stay below mandated emission limits. Or they must purchase credits from others to stay under emission caps to avoid even larger penalties.
To facilitate trading, carbon credits trade as futures on public exchanges, allowing investors to purchase them too and potentially profiting as their value grows with rising demand.
“My view is that carbon credits are essentially the currency of a net-zero future,” says Steen Rasmussen, publisher of CarbonCredits.com, based in Vancouver.
“As we transition down that pathway to this goal, carbon credits will be the major trading unit to get there.”
Although compliance carbon credit markets have been developing since the 2000s, as an investment class they’re still nascent and relatively unknown — even to investors seeking sustainable solutions for their portfolios.
“Awareness of this small asset class is minimal,” says Ryan Fontaine, a senior investment adviser specializing in responsible investment at Assiniboine Credit Union in Winnipeg.
Given the newness, carbon credits are not something he would recommend for clients as the funds in this space would be very risky.
Indeed, the compliance market is volatile.
The largest ETF in the marketplace, KraneShares Global Carbon Strategy ETF — launched in 2020 with more than US$700 million in assets — had a nearly 108 per cent return in 2021. That performance was driven by the view that tightening emissions targets in the EU and other places would increase the need for credits.
Then this year, the fund is down about 15 per cent — like other funds in the asset class — due to concerns the war in Ukraine would prompt the EU to back off reducing emission limits.
“There has been a lot of speculation that has been talked down by the European Union each time.” Wilson further notes speculators sold off futures for the EU market, which makes up about 80 per cent of the value of the global compliance market.
“That has been negative for the price of carbon overall,” he adds. Yet so too are rising interest rates and high inflation that have negatively affected stock and bond markets.
“When people are losing money in stocks and bonds, they need to raise money from other assets,” That includes selling allocations to carbon credit funds, Wilson adds.
Still, the long-term trajectory bodes well for compliance credits as emission targets become more stringent and companies must choose between investing in technology to reduce their footprint or purchasing credits to meet emission limits.
Eventually, the price of credits — driven by demand from emitters and investors — becomes more costly than projects to reduce emissions, and so emitters will then develop them to reduce their carbon footprint instead, Wilson says.
“By creating additional demand for these credits, investors are helping accelerate this transition.”
Another upside for credits — which are based on the price of one ton of emissions — is they are a way to offset oil and gas holdings, for example, in your portfolio.
Yet compliance credit markets aren’t the only way to offset your portfolio’s footprint.
There are also fast-growing voluntary carbon credit, or offset, markets worth collectively about $2 billion. The premise for investing in these voluntary credits, Rasmussen notes, is that many corporations and organizations like endowment funds — which are outside regulated carbon markets — have net-zero pledges to meet. One way to achieve them, besides cutting emissions, is purchasing voluntary credits generated by reforestation, greenspace preservation and renewable energy projects.
“Increasingly, carbon will be a line item on a financial statement, and will be a liability or an asset depending on whether a company is hitting targets or has the credits to offset them,” Rasmussen says.
Investors can go to online platforms like Terrapass to purchase voluntary credits as investments — which can be traded on a number of specialized exchanges like the Carbon Trade Exchange.
Or investors can simply buy voluntary credits, generated by climate friendly projects, to offset their lifestyle or portfolios.
“One challenge today with voluntary credits is there is no true standardization,” Rasmussen says, noting further these markets are maturing as major corporations purchase more voluntary credits to offset emissions.
Investors have other alternatives too, such as investing in companies developing environmental projects to produce credits.
That includes the Canadian publicly traded company Carbon Streaming.
“It’s almost trading at cash value now,” Rasmussen says, noting the relatively new company has fallen out of favour amid the stock market sell-off.
“All of this suggests most people haven’t really clued into the long-term upside of carbon credits.”