European Union Carbon Credits (KEUA and GRN ETF Review)

SustainFi Updated October 6, 2021

  • European Union (EU) carbon credits are one of the best-performing commodities of 2021
  • In October 2021, prices rose to €61 per ton, an increase of over 85% year-to-date
  • The EU is legally required to be carbon-neutral by 2050, which must be achieved to limit global warming to 1.5% degrees Celsius
  • In July 2021, the European Commission proposed more ambitious pollution cuts, including legislation to reduce the supply of carbon allowances
  • Many industry analysts predict prices of €100 per ton
  • There are now three ways you can invest: KRBN and KEUA exchange-traded funds (ETFs) and GRN exchange-traded note

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What are carbon credits?

Carbon credits are government-issued allowances to emit polluting greenhouse gases. Each carbon allowance permits its owner to emit one ton of carbon dioxide or CO2. Unlike many other commodities, allowances are a government construct designed to limit pollution.

Companies in polluting industries like manufacturing and energy are allocated allowances each year, but the total amount is reduced over time. Industries must transition to greener technologies or buy allowances from others. Those that decarbonize quicker can make money selling allowances. Companies are fined if they emit more than their allowance and don’t buy credits to compensate.

There are many regional markets for carbon credits. The European Union is the oldest, but there are also markets in California, the U.K., Canada, the Northeastern U.S., China, and other countries.

The EU’s Emission Trading System

The European Union is the world’s second-largest carbon market (after China’s). The world’s first emission trading system, the European Union’s Emissions Trading System (EU ETS), was introduced in 2005. Today, it operates in 27 EU countries plus Iceland, Liechtenstein, and Norway.

The scheme covers around 40% of the EU’s emissions and limits CO2 from roughly 10,000 factories and plants in energy and manufacturing. Airlines that fly in the EU are also included. Maritime should be added to the list in the future. Thanks to the scheme, emissions from covered activities dropped by about 35% between 2005 and 2019.

However, the scheme’s start was inauspicious, and initially, the EU ETS failed to make much of an impact. When the scheme first started in 2005, a lot of allowances were given out for free. Businesses were also polluting less when economic activity dropped during the financial crisis. Carbon prices fell to zero. Due to both macro factors and the initial oversupply of allowances, EUA prices continued to be low for much of the 2010s.

Because of low EUA prices, polluting businesses did not have to clean up. The system wasn’t working. So the EU decided to reduce the number of allowances in the market. The 2018 reforms reduced the oversupply of allowances through the Market Stability Reserve Mechanism and increased the rate at which allowances shrink each year.

Thanks to these measures, EUA prices rose from around €10 per ton in early 2018 to over €20 in early 2019.

Why are EUA prices going up now? 

  • EUA prices have been going up after the European Union decided to toughen its climate targets even further
  • EU carbon credits are critical in achieving the EU’s climate goals, which are legally binding
  • More detailed carbon credit proposals were introduced in July 2021
  • Speculative players like hedge funds entered the market

EUAs did even better in the second half of 2020 and 2021. European Union Allowances (EUAs) were one of the best-performing commodities of 2021, rising 85% and hitting a new record of €61.

Source: ICE

The increase in prices is the result of new policies under the ambitious European Green Deal. Launched in late 2019, the Green Deal is a set of policy proposals designed to make the EU carbon-neutral by 2050. In the meantime, the EU set a goal of reducing 2030 carbon emissions by at least 55% versus 1990 levels (from 40% previously).

Carbon credits are critical in making the EU carbon-neutral by 2050. So, in July 2021, the European Commission proposed new legislation that deals with carbon credits (the “Fit for 55 Package”).

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What does the new legislation mean for European carbon prices?

The legislation proposes changes to the EU ETS to cap the allowed emissions and add new industries that must comply with pollution caps. These changes include:

  • A new emission reduction target of 61% by 2030 vs. 2005 levels. (The current ETS was designed to cut emissions by only 43% between 2005 and 2030)
  • An increase in the Linear Reduction Factor, the rate at which carbon allowances shrink annually (to a 4.2% cut to emissions each year, if started in 2024)
  • The addition of shipping/maritime to the EU Emissions Trading Scheme from 2023. Shipowners will have to buy allowances to do business in the EU. There are still no viable, clean tanker fuel options, and the industry will likely take a long time to decarbonize

Broadly speaking, the proposed legislation will reduce the supply of allowances and increase demand, which is good for EUA prices.

Note: The legislation has been proposed by the European Commission, the executive arm of the EU. It still needs to be approved by national governments and the European Parliament. This process may take months, if not years.

How you can buy European Union carbon allowances

Individuals can’t buy allowances directly. While hedge funds and institutions can trade carbon futures, there are three easier ways for individual investors to participate:

Of the three funds, only GRN and KEUA exclusively invest in European Union Allowances (EUA).

IPath Series B Carbon ETN (GRN)

GRN is an exchange-traded note that tracks EUA prices. GRN is up 90% year-to-date through October 2021.

KraneShares European Carbon Allowance ETF (KEUA)

On October 5, 2021, ETF provider KraneShares launched an ETF exclusively focused on European carbon credits, the KraneShares European Carbon Allowance ETF (KEUA).

KEUA is benchmarked to the IHS Markit Carbon EUA Index, which tracks the most traded EUA futures contracts.

KEUA vs. GRN

TickerKEUAGRN
FundKraneShares European Carbon Allowance ETF iPath Series B Carbon ETN
TypeExchange-traded fundExchange-traded note
Date Launched20212019
Assets$4 million$86 million
Expense ratio0.79%0.75%
Year-To-Date Performance-90%
InvestmentsEuropean Union carbon allowancesEuropean Union carbon allowances

Data as of 10/5/2021

Both funds invest in EUAs and cost roughly the same, but we generally prefer the ETF structure to the ETN, and, therefore, KEUA to GRN. With the ETF, you own the assets the fund invests in, with the ETN, you do not. ETNs tend to be less popular overall.

Note: GRN is an exchange-traded note (ETN). ETNs are structured differently from ETFs – an ETN is a promissory note (a promise to pay) issued by a bank, in this case, Barclays. Unlike an ETF, which buys and holds the underlying securities, an ETN doesn’t own anything. The Note’s backer (Barclays) promises to pay the return of the index. Since the ETN does not hold securities, it can match the return of the index perfectly, eliminating tracking error. However, an ETN carries the credit risk of the issuer, so if Barclays goes bankrupt, investors may not get their money back.


The third option is KraneShares Global Carbon ETF (KRBN), an ETF that invests in EUAs as well as the California Carbon Allowances (CCA) and the Regional Greenhouse Gas Initiative (RGGI) in the northeastern U.S. However, CCA and RGGI allowances are nearly one-third of KRBN. GRN has done better this year because EUAs outperformed California and RGGI allowances, so if you are looking for a EUA pure-play, GRN or KEUA are better options.

🔔 Learn more about the KRBN ETF.