If you are an investor in the carbon market, are you helping the planet? Or are you just a ruthless speculator?

From 2021, it has been possible for UK retail investors to buy exchange-traded funds that monitor the price of carbon in the EU’s emissions trading system. By requiring polluters to hold an emission quota (EUA) to emit a ton of carbon dioxide, the idea is that as the price rises, companies will have an incentive to reduce emissions, for example by investing more in renewable energy. Companies that don’t need their permits, ideally because they emit less are free to sell them on the open market.

There are two main products available to UK-based retail investors: WisdomTree Carbon ETC and SparkChange Physical Carbon EUA ETC. (A third, also by WisdomTree, was established in April of this year and follows the much smaller carbon market in California.)

The investment case for buying a fund tied to the carbon price is that it should go up. The EU plans to release fewer EUAs in the coming years with plans to raise the price to the point where it impacts capital spending decisions by power companies and other polluters and to reduce the number of free allowances it has given out to appease the industry. It also plans to expand the scheme to cover more sectors. At present, it mainly applies to power companies and energy-intensive industries.

After reaching 100 in February, a price that could focus the mind on changing behavior, the price is now at 95 after a steep climb over the past two weeks. The performance of exchange traded commodities (ETCs) was subdued in the 12 months to early June, according to Morningstar data. At 4-5 percent, this significantly underperforms the major stock markets.

However, analysts expect the price to rise well beyond its current levels in the coming years. By 2030, they expect it to average 144, according to a survey by Carbon Pulse, though they only expect 102 by 2025, not far from the level it reached in February this year.

Volatility is high, a fact sheet from the SparkChange fund shows that while EUA prices are up 28.5% in 2020, for example, volatility has been over 51%. The previous year, volatility was still 41%, but the price increase was only 1%. This compares with stock index volatility levels which tend to be in the mid-teens.

The price of EUAs is closely linked to the price of gas, which has seen a huge increase of more than 100% this month, leading to a corresponding increase in carbon prices from 78 to 95. Mark Lewis, head of climate research at Andurand Capital Management, a hedge fund, says this has been one of the most volatile periods we’ve seen since last summer.

For some asset managers, these swings take products off the table for retail investors. These products are pretty speculative, we don’t really know what’s going to happen with them, and they’re new, says Peter Sleep, senior portfolio manager at 7IM.

But are any of these ETCs a sustainable investment?

SparkChange argues that as a physically secured fund, its product has a greater environmental impact than a futures-based product, because the fund effectively owns the EUA, taking it off the market and limiting supply for polluters. Handelsbanken, for example, holds ETC in its sustainable investor portfolio for these reasons.

The sustainability case of the WisdomTree ETC is a bit different. The factsheet focuses on the potential for returns linked to the case of rising carbon prices, stating that the fund is designed to provide investors with total return exposure to carbon futures contracts.

Where it can contribute sustainably is by introducing more liquidity into the market, WisdomTree argues: A more liquid market will in theory lead to better and more efficient pricing. The social cost of an undervalued carbon futures contract is carbon overproduction, she says in her investment case for the fund.

Billal Ismail, head of sales at SparkChange, says most investors in his ETC are institutions including asset managers and pension funds, who hold it long-term. He argues that carbon price volatility, driven partly by weather fluctuations, partly by the fact that utilities are the largest buyers of EUAs and are price independent, means that for long-term investors, declines are buying opportunity.

Carbon markets also have their thing: they have a low level of correlation with other asset classes, so they may appeal to investors looking to balance their portfolio. Cormac Nevin, fund manager at You Asset Management, says this is one of the main reasons he holds the fund in various multi-asset portfolios, including a cautious one.

However, Tara Clee, a sustainability analyst at Hargreaves Lansdown says both ETCs are held in very small quantities by clients on the trading platform. Until the price of carbon increases substantially and most sectors are included in the ETS, the effectiveness of the scheme in terms of sustainability is in question, he says, but adds: These products would be fine for customers who they wish to be exposed to decarbonization and its clear that global regulatory tailwinds will only increase the use case for these ETFs.

Investing in carbon markets likely won’t appeal to sustainability purists in the same way that buying Shell stock in the hopes of pressurizing it to cut emissions faster won’t either. Some investors prefer not to be contaminated by oil and gas companies at all. Others may feel that engaging with the carbon market can help expand it.

Others still see it as an energy transition game: you don’t need to assess sustainability to see that there’s a good investment in this area. But with the price still tied to regulatory decisions and the market relatively illiquid and volatile, only brave retail investors should dare to step in.

Alice Ross is a contributor to FT. Her book, Investing to Save the Planet, is published by Penguin Business. Chirping: @aliceemross

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