KraneShares ETF is a ‘pure play on the price of carbon’: KraneShares Head of Strategy

Luke Oliver, KraneShares Head of Strategy, joins Yahoo Finance to discuss outlook on carbon cap-and-trade programs and the impact of climate change regulations on carbon markets.

Video Transcript

ALEXIS CHRISTOFOROUS: Turning our attention now to climate change regulations, and we know that a lot of businesses have been calling to put a dollar figure on the price of carbon dioxide emissions. It's the biggest contributor to climate change. And a new exchange-traded fund is allowing investors to participate in this market.

Joining us now to talk about it is Luke Oliver. He is Head of Strategy at KraneShares. Luke, good to have you here. So talk to us about this latest ETF-- what is its name and when was it launched?

LUKE OLIVER: Well, thank you for having me. And yeah, KRBN is the global carbon ETF. And it's just reached its one-year birthday just recently at the end of July and already has raised-- today, actually, hit an all-time high of $600 million in assets under management. So it's really caught on and really resonated with investors.

And what KRBN is, it's a traditional ETF, but what it holds are long positions in carbon allowance futures. It doesn't hold any equities, doesn't hold any bonds, it holds literally direct exposure via futures in these carbon allowances. And what carbon allowances are are the allowances that the companies within the European Union, within the California program, within the regional greenhouse gas Initiative have to redeem to offset the pollution that they created through their industry. So what this is is a pure play on the price of carbon.

ALEXIS CHRISTOFOROUS: So I know the fund-- it's about a $580 million fund-- has soared more than 80% since it started trading, you said about a year ago. But you know, carbon cap and trade programs, which is what this sort of, I guess, this falls under-- they've been around for more than a decade, but a lot of them haven't performed very well. There's been low demand, there's been poor liquidity, a lot of volatility. Has that changed? Do you see that continuing to change? And why?

LUKE OLIVER: Yeah, well, I mean, volatility-- there's certainly some volatility in these markets. But certainly the size of these markets, the performance of these markets, and the liquidity of these markets continues to grow. And what we've seen is that to some degree, there's a tipping point in these prices. When these prices are set too low, they have no effect. The polluter, whether it be a power company, a steel manufacturer, cement manufacturer will just purchase these.

It takes until you hit a certain price, a certain tipping point, where at that price, the company starts to worry about that price, starts to hedge that price, starts to be more present at auctions, starts to build inventory, starts to hedge their exposure with the futures, as I mentioned. And suddenly, you get price discovery and you get speculators coming into that market-- speculators being a positive thing-- they allow the risk transfer from one party to another.

So as we see that, we see these prices really catch on. And you saw that in Europe when we went from around $30 a ton of carbon in Europe up to where we are today at about $68 a ton in carbon-- so a lot of that performance has come from Europe really going from this $30 up to the $68 we're at today through price discovery. And I call it real price discovery, because there's always a price, because prices really move.

The way we are now, we traded in this range since around May-- we're just breaking out of it today-- is we're in the phase of the evolution of this market where people are switching from coal to natural gas. So the price of natural gas is acting as a natural cap on the price of carbon right now in Europe. We're seeing that, slowly, we're exhausting all the opportunities to switch to natural gas, which is a greener fuel than coal.

And that's going to allow the price of carbon now to move to the next incremental, cheapest to abate carbon price. So we think we could see some more upside there. But to your point, the performance historically wasn't great. And I think when you look at the European Union, they have this huge overhang from the Great Financial Crisis. Also don't forget-- this is the design.

These weren't designed to disrupt business. They were designed to be a program that allowed self-discovery, allow investment to find better ways, more efficient ways to run businesses and pollute less. So the fact that these were low incomes for a period of time isn't a failure, that's by design. And these are structurally designed to rise in price and need to get much higher.

ALEXIS CHRISTOFOROUS: To your point, I think regulation is a driver of this particular industry-- had the European Green Deal, the Biden administration now taking some steps there as well. How much is regulation a mover for this market? And how much volatility might that mean for this market going forward?

LUKE OLIVER: Well, I think it has a lot to do with it. I mean, the European initiative especially has been very powerful. And the more we talk about it, the more that we've got-- we've got Climate Week in New York coming up in September. We've got COP 26 in Glasgow in Scotland coming up at the end of the year in November. These are very high profile events.

These are all pushing towards these Paris Agreement targets. And the more high profile this becomes, arguably, the higher the price of carbon will be as more awareness comes to these markets, there's more participants in those markets. I mean, every single month, there are more people participating in the auctions for these underlying allowances. The futures market have been growing tremendously over the last few years.

So as that liquidity gets deeper, markets get more efficient, we start to see prices really getting to their natural equilibriums. And there seems to be much higher than where we are today. So we have a blended price of about $38 a ton across the three markets that we cover. And we see forecasts being much, much higher than that.

And so the initiatives-- Fit for 55 that is happening in Europe-- is being very powerful towards the price of European carbon. And it's likely that we'll see the same in the US. We've seen the price of California just get into the mid-20s recently. And that feels like that's in that tipping point area where that price starts to pinch manufacturers, starts to pinch power companies, and they will start to take this market more seriously. And I think that's where we'll see this price rise to where it should be.

And don't forget-- all these programs are designed-- and through Fit for 55, the European initiative, we actually see even stricter regulation around the scheduled decline in the amount of auctioned allowances. So we'll see fewer and fewer auctions-- fewer and fewer allowances going to market, and the demand for them is mandatory and it's less elastic. So we should see the price rise-- and then at certain price level, alternative energy becomes a lot more effective.

ALEXIS CHRISTOFOROUS: All right, Luke Oliver, Head of Strategy there at KraneShares, thanks so much for being with us today.