About a year ago, Hesperian Wealth concluded research on carbon markets for our impact-oriented clients. You can access our original research here. Since then we have used an allocation to offset carbon emissions in portfolios and enable clients to support price discovery in cap-and-trade programs critical to the green transition. There have been several developments in 2024. New carbon markets have launched or will launch in various US states. And carbon prices have cheapened in the two largest markets making carbon even more attractive on an investment basis than when we first introduced it.
Some of the funds raised through California’s carbon allowance market are directed toward wildfire mitigation in an effort to counter the already manifest effects of climate change. I thought this would be interesting to note in light of the return of wildfire disasters to the state.
Carbon Markets Updates
New Carbon Market Launches
Washington state recently launched its own cap-and-trade program. According to the fund managers we follow, it is already deep enough to be investable. The administrators are working on harmonizing their program with California-Quebec’s larger market. They may link in the future providing for a more unified carbon price across states and provinces.
In other news, New York state is launching its own program. And Oregon is considering restarting theirs.
The California-Quebec Carbon Market
California Carbon Market Price Developments
California carbon allowance prices fell steeply in 2024. The decline has continued so far this year. We had only recommended an extremely small partial position because we knew these markets would be volatile like most commodities. So we, of course, recently bought more at cheaper prices for our impact-oriented clients.
But prices have fallen so much that they are approaching levels where we may even consider an allocation for our clients more broadly. The California carbon price, in particular, is close to its “auction reserve” level. Assuming this cap-and-trade program remains in place as constituted—and there’s no reason to think it won’t given the political situation in California—investors who buy in at the auction reserve price effectively lock in a worst-case long-term return of 5% plus inflation due to how the program supports prices (before fund, trading, and futures costs). That kind of return is attractive in and of itself. Yet, we think we get some diversification benefits too from carbon positions.
The last time the California carbon price fell to or below the auction reserve was in the depths of the COVID-19 market turmoil, so it took extreme events to get there. We’ll see if it gets that low again. We’re not there yet.
Why Have California Carbon Market Prices Fallen?
Why have California carbon allowance prices been falling? As with any market, it’s hard to know what is moving prices. But we don’t think this has anything to do with President Trump’s reelection. All the cap-and-trade programs operating in the US are regional alliances or state-administered. The federal government has no say. If anything, the Trump administration may even be supportive. US Treasury secretary Bessent has expressed openness to leveling a carbon tariff to make sure industries don’t just outsource emissions overseas to skirt compliance requirements at home, similar to the mechanisms recently put in place in Europe.
We think it’s more likely that speculators in California’s allowances priced in the start of widely expected favorable reforms prematurely in 2023. Then when the California Air Resources Board announced repeated delays to enacting these changes, there was an overreaction the other way. But based on the information we have at this time, these reforms are still coming this year. And they represent a further restriction of allowance supply implemented over a shorter time frame than what was proposed before. Unless carbon prices skyrocket, allowance supply is expected to contract every year looking out, eventually substantially. This is positive for investors as is the need for carbon prices to rise a long way between now and 2030 to meet program goals.
The EU Carbon Market
European carbon allowances also fell throughout 2024. More recently they have started to rebound. Still, investors are buying allowances today with implied carbon prices in the 80s that were once trading well over 100 EUR.
Overall, though, carbon prices are already much higher in Europe. So there is lower return potential, all else equal, compared to future carbon price targets than in California. Plus, they have been much more volatile and are denominated in a foreign currency which introduces another influence on total return for US dollar–based investors. On the other hand, the EU market is larger and more liquid with greater support across the continent compared to the small state and regional programs in the US.
That said, the EU program has also instituted program changes that should bolster carbon prices. The maritime and aviation sectors will no longer be completely or partially excluded and will have to start covering more and more of their emissions by purchasing allowances. This will increase buyer demand.
Hesperian’s Take: Why Invest in Carbon Markets?
For impact investors, it’s about:
- Supporting carbon prices to accelerate the climate transition and
- Offsetting carbon emissions elsewhere in their portfolio without having to rely on the companies they invest in to do it.
- Adding another diversified source of return to your portfolio that isn’t very correlated with existing investments and
- Taking advantage of tactical return opportunities in markets engineered to incentivize investors to participate and not just support prices but actively push auction clearing prices higher and higher over time to further policy goals.
Using Carbon Markets to Build a Truly Impactful Portfolio
If the environment is an important issue for you, have you offset the emissions in your portfolio or in your own life? Would you like to support the cap-and-trade programs attempting to harness the invisible hand of the market for good? Are you just interested in a diversified source of return with attractive prospects? Exposure to carbon markets allow investors to offset emissions elsewhere in their portfolio and support carbon price discovery to accelerate the climate transition. This is potentially more impactful to the global environmental project than simply screening out polluting or extractive companies in your stock fund. And at Hesperian Wealth, we think there is a solid investment case too!
Want to explore this and the other elements of what we believe is a solid, well-diversified impact portfolio strategy? Contact us for a free impact portfolio consultation:
All content presented in this article is for informational purposes only. Materials presented should not be interpreted as a solicitation or offer to buy or sell a security or the rendering of personalized investment advice, which can only be provided through one-on-one communication with a financial advisor. The content reflects the opinions of Hesperian Wealth LLC (HW), except where cited, which are subject to change at any time without notice. The information contained herein has been obtained from sources believed to be reliable, but the accuracy of the information cannot be guaranteed. All information or ideas provided should be discussed in detail with a financial, tax, or legal advisor prior to implementation.
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