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As summer heats up, so does the carbon market. In spite of many commodities experiencing a downturn, particularly within the energy sector, carbon allowances have been on a steady upward climb throughout June. This has created a potential opportunity for investors who are seeking to tap into the global performance of carbon ETFs, particularly the suite offered by KraneShares.

KraneShares European Carbon Allowance Strategy ETF (KEUA - Free Report) has jumped 22.2% so far this month, while the globally diversified KraneShares Global Carbon Strategy ETF (KRBN - Free Report) has climbed 14.7%. KraneShares California Carbon Allowance Strategy ETF (KCCA - Free Report) has gained 4%.

Cap-and-trade markets issue carbon allowances equivalent to one ton of carbon dioxide. Participants must account for their emissions at the end of each year through an equivalent amount of carbon allowances. Regulated and mandatory, these markets encompass various industries. As countries strive to reduce emissions, carbon allowances stand to benefit. Most major carbon allowance markets have built-in tightening mechanisms that decrease the supply of allowances over time. The combination of a reduced supply and increasing demand is likely to exert upward pressure on the price of carbon allowances in the years to come.

Notably, the EUA cap-and-trade program is the world's oldest and most liquid carbon allowance market. It covers approximately 40% of the EUs total emissions covering 27 EU Member States plus Iceland, Liechtenstein and Norway. The program targets reducing emissions by at least 55% of 1990 levels by 2030 and climate neutrality by 2050. The "Fit for 55" package released in 2021 set out an expansion and tightening of the program, including an increased cap reduction from 2.2% to 4.2% per year.

The carbon allowance market, especially in Europe, is currently facing a combination of challenges and opportunities. Climate concerns have been rising globally, which has led to increased interest and gains in carbon allowances, particularly in the European Union. However, the global economic slowdown and concerns of recession have had an impact on the market, leading to the prices of European Union Allowances (EUAs) falling off their February 2023 highs.

Additionally, industrial emissions, which are a large driver of carbon allowances demand, have decreased due to a drop in industrial production output. Emissions reports from 2022 also revealed lower-than-expected emissions.

The California Carbon Allowances cap-and-trade program implemented by the California Air Resources Board began in 2012 and covers approximately 80% of the state’s Green House Gas emissions. In 2014, the program was expanded to cover Quebec and its emissions. The program plans to reduce carbon levels to 60% of 1990 levels by 2030 and achieve carbon neutrality by 2045. The cap will lower carbon levels by 4% per year to achieve this objective. Further, the program has a floor price that rises 5% plus inflation adjustment each year.

ETFs in Focus

KraneShares European Carbon Allowance Strategy ETF (KEUA)

KraneShares European Carbon Allowance Strategy ETF provides targeted exposure to the EUA cap-and-trade carbon allowance program. It is benchmarked to the IHS Markit Carbon EUA Index, which tracks the most traded EUA futures contracts. As a part of the KraneShares suite of carbon ETFs, KEUA provides a new vehicle for participating in the price of carbon and hedging risk while supporting responsible investing and impact investment goals.

KraneShares European Carbon Allowance Strategy ETF has amassed $28.6 million in its asset base and charges 78 bps in annual fees. It trades in an average daily volume of 11,000 shares.

KraneShares Global Carbon Strategy ETF (KRBN)

KraneShares Global Carbon Strategy ETF is the first, largest, and most liquid publicly listed carbon allowance ETF in the world. It is benchmarked to IHS Markit’s Global Carbon Index, which offers broad coverage of cap-and-trade carbon allowances by tracking the most traded carbon credit futures contracts. Currently, the index covers the major European and North American cap-and-trade programs: EUA, California Carbon Allowances, the Regional Greenhouse Gas Initiative, and United Kingdom Allowances.

KraneShares Global Carbon Strategy ETF has AUM of $614.7 million and trades in average daily volume of 99,000 shares. It charges 78 bps in annual fees.

KraneShares California Carbon Allowance Strategy ETF (KCCA)

KraneShares California Carbon Allowance Strategy ETF provides targeted exposure to the CCA cap-and-trade carbon allowance program. It is benchmarked to the IHS Markit Carbon CCA Index, which tracks the most traded CCA futures contracts.

KraneShares California Carbon Allowance Strategy ETF has accumulated $236.7 million in its asset base and charges 78 bps in annual fees. It trades in a volume of 21,0000 shares per day on average.

Bright Outlook

The longer-term outlook for the carbon allowance market is promising. After the summer of 2023, the carbon permit supply is set to increase with 16.5 million EUAs added to the supply beginning in September, which means a short-term supply surplus but longer-term supply tightening.

Between September of 2023 and August 2024, 270 million EUAs will be pulled from the market and placed in the Market Stability Reserve, which mitigates strong volatility by withdrawing or injecting additional allowances into the market depending on the number of allowances currently circulating. The EU market tightens every year, with fewer allowances issued, creating greater scarcity while more participants continue to enter the market. This trend is expected to continue tightening the overall supply over time.

Additionally, legislative actions such as the REPowerEU and the recently passed "Fit for 55" legislation are expected to create long-term strength for carbon allowance prices.

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