Carbon Markets with Clearblue's Anop Pandey

Investing in carbon credits is a more than US$850B market. COVID-19 failed to curtail demand in a market that rose 164% in 2021. So what is a carbon market and how can we invest in the Energy Transition Economy? Clear Blue Market’s Anop Pandey joins Hainsworthtv to look at the opportunities in going green.

Part of Ninepoint’s Alt Thinking Podcast Series. Available at Google, Apple, and Spotify Podcasts.

Michael Hainsworth:
The carbon markets present an investment opportunity. In 2021, even at the height of the pandemic, the value of traded global markets for carbon credits grew 164% to more than US$850B. But what is the energy transition economy and how do ETS markets work? Clearblue Markets has an international presence and experience across a broad range of carbon pricing, fuel standard and energy markets. It's involved in carbon programs like Canada's Federal Backstop, the WCI and markets from Quebec to California and a Pandey is the manager market analysis at Clearblue. We began our conversation by defining the "energy transition economy".

Anop Pandey:
It's an interesting development now as the whole world is taking climate change seriously. So there is an importance in terms of switching from carbon emitting fuel sources to more clean, renewable sources. So there's a huge push on that site now, which requires both efforts and capital to make that happen.

Michael Hainsworth:
And there are many aspects to the energy transition economy. Carbon market is just one of them.

Anop Pandey:
That is correct. So carbon market access like an incentives, as a way to essentially put a price on emissions to incentivize individuals, company, society as a whole to abate their emission footprint, carbon footprint, and essentially transition into a lower carbon footprint society.

Michael Hainsworth:
The idea being that any company that is emitting a certain amount of greenhouse gas emissions can buy carbon credits to offset that from someone else who isn't producing as much greenhouse gas emissions as they've been allocated?

Anop Pandey:
That's correct in broad stroke ladder, that's correct. Obviously the different programs around the world and the way each program work will be different. It could either be a compliance program where companies would need to actually submit their carbon allowances, or it could be just a voluntary commitment by individuals or companies that want to reduce their emissions. So it really comes down to what the program is and what's being covered.

Michael Hainsworth:
So within a carbon markets, how does a carbon credits value fluctuate when the ultimate goal is to reduce GHG?

Anop Pandey:
So that really comes down to that type of market. So in a typical, let's say carbon trade market, there will be a limited amount of supply in this case, carbon allowances, where each company within the system needs to submit these allowances for compliance. So the price of a carbon allowances in a compliance program will really comes down to the supply and demand of these allowances. If the program is really tight, there's only a mid amount of allowances available. Obviously price is going to go up at the same time. If the program is loose, if the carbon is set too high, for example, there would be plenty of allowances around costing prices to fall. And then obviously processes will be influenced by emission trends. So if, let's say this a higher, faster than expected adoption of electric vehicles, which significantly reduce emission, then the value of these allowances would likely fall in a compliance system.

Michael Hainsworth:
Ultimately because less demand leads to a lower price.

Anop Pandey:
Exactly. I mean, just like any other economic market out there, more demand, higher price, less demand, lower price.

Michael Hainsworth:
You mentioned that there are two types of carbon markets, the voluntary in the compliance market. You can buy a car, been credited in a voluntary market to meet compliance, but you can't buy a credit in a compliance market and sell it on the voluntary market?

Anop Pandey:
In terms of buying a voluntary credit and into the compliance system that would really depend on the compliance market and the rules there. For example, there's the WCI carbon trade market, which is the carbon trade market for California and Quebec. In this market, there's an option to buy offsets, these offsets also traded on the voluntary market, but there's the WCI allows certain type of offset from certain geography to be used within the DVCI system up to a certain quarter. So in that sense that yes, you would buy an offset. That's also trading on a voluntary market to use for compliance in the WCI.

On the flip side, usually because a compliance carbon allowances are usually more expensive than a voluntary offsets. The price voluntary players usually would not buy compliance instrument for their voluntary retirement. That being said, there are companies out there who are pioneering this things where they essentially just buy carbon allowances from a compliance program, like the WCI, and essentially just hold it forever without the intention of ever retiring it. So essentially there are... and then offering this to companies to voluntary offset the emissions. So there are ways around. Certainly there are people trying to do that. It's just not as common as usually the two markets kind of stays separate and doesn't really interact too much with each other.

Michael Hainsworth:
You brought up an interesting point about retiring. If the ultimate goal is to reduce greenhouse gas emissions, do we have a finite number of credits? And do we eliminate them over time, much like the opposite of say a Bitcoin mining scenario?

Anop Pandey:
That's that is certainly how the, let's say a home science program would work. Like let's say a carbon pay program in a typical carbon trade program, a cap will be set and a cap is essentially the amount of allowances available per year. And with the goal of these... and then the cap will be reduced over time to whatever goal that compliance program is aiming at. So the amount of allowances available to market will be lower and lower every year with the intention of essentially making the allowances more expensive, more scarce, the supply out there. In terms of, and then for the voluntary side, that's a little bit more complicated in that because it's not a compliance program. Nobody's really setting up like a cap or a limit on allowance on the carbon credits.

So in theory, you could come up with as many emission reduction project that you want, so there's no limit on the supply. Obviously you would need to go through a variety of verification and those things that would kind of slow down supply a bit, but ultimately you could create as many solar farm projects as you want globally. Obviously there would be a demand for that like, I mean, as a certain amount, you would not need electricity anymore. There's only a certain amount of demand for electricity, or if it's a forestry project, which is a really popular project where in the voluntary markets, there's only so much land out there for you to create a forestry project. So in that sense, there's a limit on supply, but it's not as explicit as a compliance program.

Michael Hainsworth:
Who's in charge of an ETS market in the first place. You know, there are more than 30 of them around the world. And some of the multiple ones within any given country like Canada, for example, has more than one.

Anop Pandey:
Yeah. So for an ETS, it would essentially be regulated by a government entity. So for example, in Quebec, which runs a carbon trade program, the ministry of environment that MELCC runs the carbon trade program there. And in Alberta would have its own ministry of environment at once its own ETS program. So it usually would be like a either a federal government or a provincial or state authority that would run some environmental ministry in those government would be the one that are monitoring and regulating the ETS.

Michael Hainsworth:
So this is not too much different than say having the securities and exchange commission in the United States oversee multiple equity stock bond markets in one particular jurisdiction.

Anop Pandey:
Yeah, exactly. It's the same way. So these environmental ministries are essentially just coming up with regulation, setting the cap, monitoring the cap, see if it's enough or changes need to be made in as the program goes on.

Michael Hainsworth:
So if the EU is the biggest ETS market, what's Canada's carbon market look like by comparison?

Anop Pandey:
It certainly will be less and less smaller. I guess the the biggest value that we have now in terms of putting a price on the market value would be the Quebec market since Quebec and California are running their own market. So you have to consider both the Quebec province and California State together. And currently right now both of these markets have a market very low around $20 billion. So in comparison to EU, which is over 200 billion. So as you can see, even the biggest market in Canada is still 10 times smaller than the EU market. And then all the other provincial markets are even much more smaller since the scope of dose program and as big as Quebec or that's it kind of interact with other programs or states in their programs.

Michael Hainsworth:
So how liquid are these markets?

Anop Pandey:
So Quebec market is very liquid. Since their allowances are traded on an exchange, you can see pricing essentially on a daily basis. You can easily trade their allowances. So it's a quite liquid market. The EU ETS is all very liquid market. There's always a lot of trading, but then other ETS market, with like other provinces in Canada, for example, one be as liquid, since that program are usually limited and certain ETS also limit who can buy their allowances. The Nova Scotia carbon trade, for example, currently does not allow non-compliance entities to buy their allowances. So their market is essentially limited to the home client entities in the province. So it's not a really quick market. So it really just depends on who's allowed to buy the allowances and essentially how big those markets are.

Michael Hainsworth:
You mentioned compliance, what's the cost of non-compliance?

Anop Pandey:
So again, that would differ by market. For an ETS, usually since it's a legally binding legislation. And so there are these... So it's a very... For non-compliance, the cost of non-compliance is usually very high. Usually it's three to four times the cost of compliance. Usually will be legally required to submit, let's say three allowances for each timed-out of greenhouse gas that you don't comply with. So the cost of compliances is quite high. And since this is a legally binding scheme, there's a legal authority by the government and by the liquidating agency to essentially make you pay this non-compliance fee. So yeah, so the cost of non-compliance would be quite significant.

Michael Hainsworth:
In the world of stocks. I can buy a stock, I can buy an exchange traded fund. I can buy a stock based in a futures index, for example, what about the world of the energy transition economy and ETSs? How complex are the investment options in securities?

Anop Pandey:
It used to be quite hard, but it has since have gotten much easier for you to get exposure to the biggest carbon markets out there. So for the EU ETS, the Quebec-California market at WCI and the [inaudible 00:14:01] market, which is another carbon trade market in northeastern in the United States. Right now, their ETFs that track these carbon allowances, the ETFs will essentially buy the carbon allowances, really giving the retail investors a pretty easy way to buy and get exposure to the carbon markets.

Anop Pandey:
Also, there are futures that are traded on these stream markets. So you could essentially get exposure to the futures there, if you want to get more direct exposure. There's also opportunities to buy allowances, physical allowances for your account. These are harder to do since usually would have to open some kind of account with a direct heading authority would need to have certain amount of monetary guarantees. And then you need to source the allowances, fiscal allowances yourself, which is harder. But essentially the easiest way to get exposure to these market would be through the new ETFs coming out

Michael Hainsworth:
COVID-19 has touched every aspect of the broader markets. How has the pandemic affected the ETS markets?

Anop Pandey:
So when the COVID 19 first started in beginning of 2020, you saw a crash in the ETS prices across the globe. Prices went down significantly, but it has since recovered quite quickly as well. Like you see with, I guess, with the other asset classes in a way, because the market then becomes to realize that, just because there is a pandemic, emission essentially it's not going away.

Anop Pandey:
Certainly in the WCI market where one of the industry being covered is the transportation sector, which is the gas you feel up your car, certainly that particular sector, you do see a lot less driving, a lot consumption of oil. So you do see a drop in emission. But that was very brief and the emission came back quite quickly. So the market, as a whole realized that emission would come back. It is there and the rules there are still standing and the government still want to the emission reduction goal that they set out, whatever that is. So the rebound in price came fast and just in 2021, the price of all ETS went up quite significantly. So the pandemic had a short but painful effect on the ETS, but the recovery was as fast.

Michael Hainsworth:
So then with that in mind, what's your forecast for supply and demand as we come out on the other side of COVID 19?

Anop Pandey:
So that would certainly depends on each market, but overall the trend would be that the supply demand will still get very tight. The cap set by the government entities. It is very tight and as we proceed on, in a decade, you would see the supply of allowances shrink and shrink. And then for most of the markets, the supply would be defeated usually by 2030, when these government has set their kind of image reduction goal. So when going forward, we still expect the market to be very tight for all of the ETS.

Michael Hainsworth:
So you help develop financial models for these markets. How does that work? How does your day job go?

Anop Pandey:
It always comes down to demand and supply. So essentially we'll look at what happens on the demand side and what happens on the supply side. So on the demand side, we try to look at what will be the future trends of emissions in each of the sector within ETS. I work a lot with the WCI. So I'll give an example there. So within the WCI, there are plenty of sectors under coverage being a fuel distributor, which is the transportation sector, the power generators. And then there are other sectors just as the industrial sector, [inaudible 00:18:29], metal minings and things like that. For the WCI as a whole, by far, the largest sector is the fuel distribution sector, which is all the oil and gas that people fill up in their car and drive. So we would try to forecast what would be like the driving behavior of people going forward in a short and law long term.

And also since one of the big development right now is the adoption of electric vehicle. So we'll try to make a forecast on how many electric vehicle could be ad adopted over the next, let's say decade, and what the pace of adoption would mean for the emission over the next decade. So that would essentially inform our demand and we'll do the same thing for all the sectors under coverage. And on the supply side, the government would already set along a supply. So over the next 10 years, we already know what the cap will be for each year. What we try to do on supply side is try to make assumptions on, if, let's say there will be a change through the cap, if there's a need, a call for the Quebec government to reduce emission faster, for example, there could be a reduction in the cap. So we try to model those in and essentially look at what the dynamic could mean the supply and demand is, to essentially come up with cumulative supply demand thicker and how would that influence the allowance prices.

Michael Hainsworth:
On the demand side, you mentioned electric vehicles are EVs the biggest factor that you're keeping an eye on through the course of the next decade, that influences the demand side of the equation.

Anop Pandey:
EV is certainly a huge one, but there are other factors also in consideration for the fuel sector. For example, another big trend is the use of renewable fuels. So things like ethanol or things like renewable diesel or biodiesel. That's also a big trend coming up. There's a lot of new capacity coming up there. And another big trend is essentially on especially on the power generation side, the adoption of renewable sources of energy. As you can see, there's been a lot of talk about putting things like solar and wind power on the electricity grid. So we keep track of that as well to see what's coming online and how much would that displace fossil fuel sources of energy.

Michael Hainsworth:
Did geopolitics impact ETS markets? I'm thinking about the situation that is raveling with Russia right now, and the concerns about where Europe is going to get its fuel for the remainder of the winter. Do things like that move the market substantially?

Anop Pandey:
Oh, certainly, the concern with gas supply in Europe has in significantly increased natural gas prices in Europe. So the EU ETS is very sensitive to movement in natural gas because there's still a lot of coal power plants within the continent. So if the natural gas prices gets higher, it'll be more profitable for power producers to use coal power plans, which essentially, emit more emission causing higher demand for allowances. So that's why you are seeing the EU ETS allowances reaching new high in 2022. And a lot of that has to do with the uncertainty on the gas prices in Europe.

Michael Hainsworth:
Gas prices certainly playing a role in the global inflationary picture right now, can carbon service a hedge against inflation?

Anop Pandey:
For sure. So there are, I guess in a direct way, that those allowances, for example, there's a floor price that's set for the market and that price increases by 5% plus inflation. So in that sense that, yes, there's a direct connection between inflation and allowance prices. And on the other side, like you said, as more and more gas has to burn, the more emission you release. So that essentially lead to the use for carbon costs within the gas industry. So by buying, let's say carbon allowances, you might be hedging the carbon price that is being put on vehicles fuel or natural gas. So yeah, in that side there is certainly a inflation protection mechanics within the carbon price.

Michael Hainsworth:
If there's one thing you want the listener of this podcast to walk away with when it comes to an understanding of carbon credits and the energy transition economy, what's that one thing?

Anop Pandey:
I would say it has to do with essentially the carbon prices incentive to abate emission. One thing I would try to people to keep in mind is to essentially achieve that energy transition that needs to be more price and carbon, and the carbon market is really helpful for that. So essentially higher carbon price would lead to a faster energy transition.

Michael Hainsworth:
And thank you so much for your time and insight today.

Anop Pandey:
Thank you so much. Thanks for having me.

Michael Hainsworth:
Anop Pandey is the manager of the market analysis team at Clearblue. I'm Michael Haynesworth. Thanks for listening.

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Part of Ninepoint’s Alt Thinking Podcast Series. Available at Google, Apple, and Spotify Podcasts.