Carbon pricing establishes a tangible and direct cost/benefit to companies based on their carbon emissions, which are traditionally an invisible by-product, according to UBS Global Wealth Management.
China launched its carbon emissions trading system (ETS) in July 2021, but trading volumes in China ETS remain small (versus total national emissions of an estimated 14 GtCO2), and access is restricted to participating companies. While a futures market is being discussed, this will likely be a medium-term event, Stephanie Choi, sustainable & impact investing strategist, at UBS said in a research report.
Over the 114 trading days in its first calendar year, compliance completion rate reached 99.5%, translating to a total volume traded of 179 mtCO2, or RMB7.66bn. Price levels rose 13% to close at RMB54.22/ tCO2.
Opportunities
Nevertheless, Choi argues that although the direct access to the China ETS is limited, investors could position investment portfolios accordingly:
First, invest in sector leaders which exhibit above-peer ability to manage emissions and energy transition, especially in anticipation of continued sector rollout.
Second, invest in select green-tech players which may find additional revenue sources from the sale of carbon credits.
Finally, invest in directional carbon exposure through international markets, including both regulatory and voluntary carbon credits.
China’s ETS focus is on the power sector at present, but for this sector the cost of abatement (emission reductions) is relatively low due to the availability of alternative feedstock and mature technologies,
“Companies may therefore prefer abatement to paying up. This will change as the rollout spreads to other industrials, including hard-to-abate sectors such as steel and cement in the next phase,” Choi said.
As ETS coverage continues to get rolled out, it could drive a meaningful differentiation between players based on their preparedness for this sea-change, she added.
“A universal carbon price is an ideal outcome; and on a global basis, the International Energy Agency (IEA) sees carbon prices reaching $130/t CO2 by 2030 if net zero by 2050 is to be met. Having said that, the route and pace at which this could be achieved could differ a lot depending on the structure and associated policy set-up in different countries.”
Risks
However, Choi warned that investors interested in participating in regulatory carbon markets should be aware of several risks.
For instance, markets are either at nascent or early maturing stages, which means that both prices and liquidity could be volatile. In addition, regulatory carbon allowances are digital assets, with no fundamental cash flows, which implies their value rests entirely on policy direction and market dynamics.
“There is no universal standard for regulatory carbon market design, and policymakers may choose to adjust structures or parameters, which could result in significant financial impacts on positions,” she stressed.
Investment solutions that offer access to these markets may lack maturity, for example in scale, liquidity, or track record. While unlikely, any shifts in political commitment to decarbonisation could sharply affect market fundamentals and pricing dynamics alike, said Choi.
