Carbon dioxide (CO2) levels have climbed by 41 percent since 1990, and a plan to minimize carbon emissions won't show success immediately.
Carbon credit systems have become a niche that is steadily gaining momentum in several places.
A corporation can obtain carbon credits by offsetting their carbon emissions by using less than their authorized cap or purchasing credits from another company that has more than they need.
The European Union's desire to counteract the impacts of pollution resulted in creating the first Emissions Trading System, or ETS. They sought to reduce greenhouse gas emissions by at least 55% compared to 1990, and the European Union ETS was established in 2005 to achieve it by 2030.
This program inspired the formation of comparable organizations and programs, notably those aimed at regionally lowering California and New England emissions.
Carbon credits are sometimes referred to as carbon allowances. They are a government-issued permit to pollute. These punishments are commonly imposed on polluting companies, such as cement producers or utility administrators. By purchasing carbon credits, these businesses can commit to emitting a certain quantity of carbon and other greenhouse gases each year.
Certain polluters are more effective at reducing their emissions than others and can sell remaining credits to others.
With time, the government can reduce the amount of credit it grants, allowing companies to become even more efficient by investing in greener technologies.
Types of Carbon Credits
You can invest in two types of carbon credits: Voluntary emissions reduction (VER) and Certified emissions reduction (CER) (CER). VER is a term that refers to a carbon offset that can be exchanged for carbon credits OTC (over-the-counter) or on the voluntary market.
CERs are emission units (credits) produced within a legal framework to offset or neutralize a company's carbon emissions.
What is the critical distinction between the two? Unlike the VER, the CER is regulated by a third-party institution that validates the credits.
The risks of carbon credits
Carbon credits are not an all-or-nothing proposition. Bear in mind that they are not backed by any real product, such as gold or natural gas. Carbon credits are a political construct devised by organizations such as the European Union, the United Kingdom, and the State of California. As a result, their continued existence and prices are contingent on the regulators' goodwill.
Certain politicians have attributed Europe's high energy prices to the existence of carbon trading schemes, which they believe increased electricity prices for ordinary people. The EU has been urged to rein down speculation on carbon markets. And there is always the risk that governments would intervene if prices grow to an unsustainable level.
In Europe, for example, the government can set new allowances to pressure prices downward if they remain excessively high for an extended length of time.
Pros
As with any investment, one of the primary benefits of investing in carbon credits is the potential for financial gain. As previously stated, the KraneShares Global Carbon Strategy ETF's value has doubled since its inception in mid-2020, resulting in a NAV return of more than 154 percent as of Dec. 31, 2021.
Environmentally friendly: Carbon credits limit corporations' annual carbon emissions to a particular level. Environmentally conscious investors may look to carbon credits to invest in following their ideals.
Investment options that are easily accessible: Carbon credits investing does not have to be difficult. Carbon-credit ETFs enable investors to have exposure to carbon offsets without choosing and choosing individual companies or engaging in carbon futures trading.
Cons
Possibly risky: As with any investment, investing in carbon credits carries certain risks. Carbon-credit exchange-traded funds (ETFs) follow the performance of carbon futures contracts. Futures contracts are notoriously volatile and are often regarded as a sophisticated investment technique. Additionally, because carbon-credit investments are new, there is a limited track record to evaluate.
Diversification is limited: Many individuals enjoy ETFs because they can help diversify a portfolio. On the other hand, diversification is limited in the case of carbon-credit ETFs. Allowing carbon credits to account for a disproportionately high portion of your portfolio might potentially increase your risk.
While carbon credits are intended to reduce a company's overall carbon emissions, their environmental impact is debatable. To begin with, these programs are not widely available in the United States. Cap-and-trade programs are only available in the eastern United States and California. 6 Additionally, companies can purchase additional carbon credits rather than reducing their carbon emissions, which has no positive environmental benefit although serving as a financial penalty.
As previously said, if you choose to invest in carbon credits, you would most likely purchase an ETF or ETN. These investments are made in carbon futures contracts that track the price of carbon. In other words, they are not highly correlated with price prices. As a result, they can help diversify your portfolio if it is mostly comprised of stocks and bonds.
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Additionally, carbon credits can be an excellent investment if you're looking to invest in the energy transition. While they are undoubtedly unconventional assets, prices will almost surely rise when carbon allowances are phased out, hence increasing prices. As a result, they may be worth considering for a portion of your portfolio.
To begin, there are two points to examine. To begin, the credit must represent at least one metric ton of additional, unclaimed carbon dioxide emission removal or reduction on a permanent basis. Second, it must result from non-intrinsically destructive behaviors to the environment or society.
Governments can gradually reduce the availability of carbon credits, increasing the price. What does that accomplish?
It makes doing business more expensive if you are a repeat offender who repeatedly abuses carbon emissions. However, companies that sell their credits because they are continuously below the limit profit from the credits.
To acquire carbon credits, investors must pursue novel channels. As an individual, you will be unable to directly access carbon credit inventories. You will, however, be able to invest in exchange-traded funds, or ETFs, which incorporate a variety of different sorts of equities.
This comprises forward contracts, carbon offsets, and carbon credits, among other products. It's critical to understand the difference between stocks and ETFs. A stock is a single share in a single company, but an ETF is an investment of numerous stocks.
They can be exchanged on the stock exchange in the same way as stocks are. Depending on the business, they are less risky in some circumstances, although this is not always the case.
How To Invest in Carbon Credits
In the United States, carbon emission reduction programs are mostly voluntary and do not exist in the majority of states. As a result, the investment options for carbon credits are limited (although there likely will be more in the future). Having said that, here are a few methods for investors to get started.
An exchange-traded fund (ETF) is a type of pooled investment that attempts to replicate the performance of underlying assets. A carbon-credit exchange-traded fund (ETF) tracks the carbon market's performance.
For instance, the KraneShares Global Carbon Strategy ETF (KRBN) is benchmarked against the IHS Markit Global Carbon Index, which tracks carbon-credit futures contracts (we'll discuss carbon-credit futures contracts in further detail shortly). What established the fund in 2020 and, as of Dec. 31, 2021, has grown by more than 154 percent in terms of net asset value (NAV).
Additionally, the KraneShares European Carbon Allowance Strategy ETF (KEUA) and the KraneShares California Carbon Allowance Strategy ETF are comparable products (KCCA).
Carbon-Credit Futures
Carbon futures are another way to invest in carbon credits. A futures contract is a sort of derivative contract in which two parties agree to exchange an underlying asset at a certain price on a predetermined date. Carbon credits serve as the underlying asset in these futures contracts.
It's worth noting that futures contracts represent a more sophisticated kind of trading. Indeed, carbon-credit futures offer a more difficult manner of investing in the assets underlying the ETFs outlined previously, as those ETFs monitor the performance of carbon-credit futures. Carbon-credit ETFs are more accessible to individual investors.
Individual Companies
Individual investors can also invest indirectly in carbon credits by investing in companies that trade them. Microsoft, for example, has established a goal of becoming "carbon negative" by 2030 and has contracted 1.3 million carbon offset credits for 2021 as part of that endeavor.
Shell is another company that is active in the carbon credit market. However, rather than purchasing carbon credits, Shell sells and trades them with other companies, reinvesting the earnings in its global portfolio of environmental products.
1. KraneShares European Carbon Allowance (KEUA)
The KEUA is a market-cap weighted exchange-traded fund that invests exclusively in European Union allowances. This stock is ideal for anyone looking to avoid the US market entirely.
This index tracks the most actively traded futures contracts in the European Union.
This fund, which was launched in October, is still in its infancy, with assets totaling just less than $4 million. Even though it is a modest fund, a sizable market exists for EU permissions. According to KraneShares, $30 billion in EUA carbon permits will be exchanged each month through 2021.
Additionally, the correlation between traditional assets and carbon allowances is negligible, implying that EUAs might be used as a hedge.
It's a fantastic option for individuals looking to invest exclusively in the European carbon market. EUAs represent a sizable market, and the purchasers gain access to a hedge fund.
2. KraneShares California Carbon Allowance ETF (NYSE: KCCA)
As expected, the KraneShares California Carbon Allowance ETF (KCCA) is another KraneShares carbon allowance ETF. On the other hand, this ETF is focused on the California market. This fund, which was also created in October 2021, has already amassed approximately $82 million in assets. It is calculated using the IHS Markit Carbon CCA Index, which is a benchmark for the most actively traded carbon credit futures contracts.
Carbon allowances are a result of California's cap-and-trade scheme. The California Air Resources Board first proposed this in 2012. (CARB). By 2030, it plans to reduce carbon emissions to 60% of 1990 levels and attain carbon neutrality by 2045. While this fund is significantly larger in terms of total assets than KEUA, its monthly trading volume is far smaller at $1.5 billion.
When considering carbon credit equities in aggregate, KCCA is already looking like a compelling investment possibility; a $10,000 investment in early October would have increased to more than $12,000. This is despite the expense ratio remaining the same at 0.79 percent.
3. Canadian Solar Inc. (CSIQ)
The US Department of Energy recently released a paper outlining their assessment of the solar future to shift close to 40% of the nation's electricity usage to solar energy.
That occurred on Sept. 9, and it is consistent with President Biden's green initiative plan. This idea might be implemented into the American Jobs Plan, benefiting companies such as Canadian Solar Inc.
Analysts are bullish about the company's prospects, with a Citigroup representative giving the stock a Buy rating and a target price of $57 in August.
CSIQ is invested in 13 hedge funds, with a total value of $95 million. At present, investors can enter the solar panel sector of energy equities at a discount. The government recently determined to minimize its reliance on Chinese solar panel imports.
The effect across the stock market was a sell-off in solar stocks, resulting in a decline in share prices. Many believe the move is only temporary, anticipating that increased demand will result in higher costs once it is lifted.
4. Orbital Energy Group, Inc. (OEG)
According to NASDAQ, orbital Energy Group, Inc. (OEG) is one of the few stocks in which hedge fund investors have invested despite the stock trading at less than $5 per share. This demonstrates that the low price does not imply that OEG is not worth the money.
One possible explanation for this is that the company, which provides electric power and solar infrastructure, has garnered investment from a number of worldwide hedge funds.
OEG was recently awarded a contract to build a more than 2,000-mile rural broadband network in Virginia. Additionally, the agency has pledged to assist victims of Hurricane Ida, particularly with regard to the utility infrastructure, which was in severe condition. This entails a long-term commitment to underserved populations.
According to Insider Monkey, four hedge fund managers currently control little more than $4 million in OEG stock.
5. iPath Series B Carbon ETN (NYSE: GRN)
The iPath Series B Carbon ETN (GRN) is an exchange-traded note that tracks the Barclays Global Carbon II TR USD Index. It does so by utilizing the European Union's Emission Trading System (EU ETS) and the Kyoto Protocol's Clean Development Mechanism (CDM). This fund was launched in September 2019 and has already amassed more than $100 million in market capitalization.
Bear in mind that this product is an exchange-traded note (ETN), not an exchange-traded fund (ETF). You own the underlying asset when you invest in an ETF, whereas ETNs are unsecured debt securities that behave more like bonds.
iPath does not provide returns for its ETN. However, the Barclays index has a 1-year return of 146.79 percent. If you invest in it, you will pay fees similar to those charged by ETFs; it has an expense ratio of 0.75 percent.
6. Regional Greenhouse Gas Initiative (RGGI)
RGGI (pronounced "Reggie") is a carbon emissions trading initiative launched in 2009 by 11 northeastern states, including Connecticut, Delaware, Maine, Maryland, Massachusetts, New Hampshire, New Jersey, New York, Rhode Island, Vermont, and Virginia. Permits are auctioned off to power plants as part of the process. The program is more limited in scope than the one in California, despite costs that have been growing.
7. Plug Power Inc. (PLUG)
Plug Power is an innovator in the field of energy conservation, specializing in hydrogen fuel cell systems. Though this clean energy technology receives less attention than hydro and solar energy, there is reason to expect that it will gain popularity in the future.
PLUG's growth as a company has been phenomenal over the last few years, with share prices soaring by more than 61 percent in only one year. It's a climate change stock worth investigating since some analysts are beginning to believe the new technology's buzz and the company's buy rating.
Plug Power, Inc. and the top firm DE Shaw has invested investments from 34 hedge funds. This company owns 14 million shares with a market value of more than $507 million. While the stock is still in its infancy and prices have not yet reached astronomical levels, PLUG is a reasonable stock to invest in if you are willing to make a long-term commitment in exchange for a larger return.
8. Sunworks, Inc. (SUNW)
With five hedge funds in the market database totaling slightly more than $3 million, market analysts are confident in Sunworks, Inc.'s potential growth.
In October 2021, Jefferies Group, LLC, a world-renowned financial services company headquartered in New York City, forecasted a 25% increase in solar PV (photovoltaic) installation.
The rationale was that prices would remain high due to manufacturing constraints. Sunworks is a manufacturer and distributor of photovoltaic (PV) energy solutions. After this projection became public, the price of a share surged by more than 13%.
Sunworks, Inc. has consistently outperformed market expectations in terms of earnings per share and revenue growth of more than 230 percent year over year.
This past June, the company enhanced its visibility by joining the Russell Microcap Index. Additionally, they acquired a fast-growing solar company, Solcius, demonstrating their commitment to their company's growth.
Final thoughts
Carbon credits enable businesses to earn money while simultaneously reducing their carbon footprint. In essence, a cap specifies the maximum amount of carbon emissions that a business is permitted to release. Although carbon credits are not as widely used in the United States as in other areas of the world, multiple states have joined regional programs to promote their use. Additionally, investors may profit from the sale of carbon credits.
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