An investor’s guide to Physical Carbon Allowances (EUAs)

Learn more about our Physical Carbon ETC

Part 1: An investor’s guide to Physical Carbon Allowances (EUAs)

Part 2: Investment Case for Physical Carbon EUAs

Carbon markets exist to fight climate change

CO2 emissions are heating up the planet to catastrophic effect with far-reaching commercial and humanitarian consequences. In the last 3 years, the average annual costs related to climate change in the US alone exceeded $150bn.[1] 7m people die annually due to emissions and climate-related disasters such as droughts, wildfires, and flooding.[[2]]

Despite the urgent need to solve one of the greatest challenges of our time, the gap is widening between climate ambition and reality. In order to achieve a 1.5 °C warming scenario in line with science-based targets to mitigate warming effects, the world must reduce emissions by 57% (compared to 2005 levels) by 2030.[[3]] In contrast, the Paris Agreement has so far pledged less than 2% in emission reductions.[[4]]

To address this global challenge, corporations and citizens have voluntarily supported emission reductions through offset markets. This practice is commonly best understood as planting trees to compensate for emissions elsewhere. While some offsets can play a role in mitigating global warming, much of this activity is unregulated, leading to mixed quality, with an EU report stating that 85% of offset projects fail to deliver the environmental impact claimed.[[5]]

Removing existing carbon dioxide from the air will be necessary to meet climate goals but cutting emissions (so they do not enter the atmosphere in the first place) should be the highest priority. In response, many governments have created regulated carbon markets that are designed to ‘cap’ pollution and force down emissions over time. This goes a step further than most offset schemes, which compensate for existing emissions but do not stop emissions from occurring.

How do regulated carbon markets work?

Under a ‘Cap-and-Trade’ system, polluters must obtain Carbon Emission Allowances from regulators – each allowance permits them to emit 1 tonne of CO2.

These allowances are issued by the regulator and sold via auctions or handed out for free. Energy Suppliers and Industrial firms such as Cement and Steel producers are examples of companies that must comply with this regulation.

Polluters are given a choice: they can either reduce emissions or compete to buy more allowances.

To aid decarbonisation and the transition to net zero, the supply of allowances is ‘capped’. This cap is reduced every year in order to drive down emissions. Fewer and fewer allowances means that their scarcity value increases, driving up the carbon price. In turn, a rising carbon price incentivises polluters to invest in emission reduction technologies as they become more economical than buying carbon allowances.

The EU Emissions Trading System: a large, reformed market with positive outlook

Founded in 2008 as the EU’s main tool to achieve decarbonisation, the EU Emissions Trading System (ETS) is the world’s largest carbon market.[[6]] More than 13,000 entities are covered by the system, comprising over 40% of the EU’s emissions.[[7]]

In its early stages, the ETS suffered from teething problems that included periods of significant volatility and low prices. In order to address these challenges and improve overall stability, the Market Stability Reserve (MSR) was introduced as part of reforms in 2015. Since the full formulation of the MSR in 2017, confidence in the market has significantly improved and the carbon price has increased 270%.[[8]]

The outlook for the future of the ETS is positive, with the EU already tightening its 2030 target.

– In July 2021, the ‘Fit for 55’ legislative package was issued to reduce supply significantly and expand scope of the ETS to shipping.

– The technological “quick wins” have already occurred; further emission reductions now require higher prices


European Carbon Allowances (EUAs) as an asset class

Market characteristics [[9]]

Year operationalCovered entitiesMarket size (2020)Daily traded volume

Strong return profile [[10]]

ReturnsYTD1 yr3 yr5 yrSince 2013
Annual Returns84%115%128%171%125%
StdDev annualised41%43%49%49%54%
Sharpe Ratio1.661.510.440.770.11

Low correlation to other asset classes [[11]]


Please note that all performance figures are showing net data.

What’s driving investor interest in the EUA carbon market?

Several social and market factors are driving growth of the EUA carbon market. These include increasing social pressure on investors to act responsibly, demand for new solutions to integrate climate risk into portfolios, and bullish market forecasts in light of tightening emissions regulation.

Price forecasts

As of July 2021, the price of European carbon allowances was €55 per tonne of CO2. In the same month, new EU legislation proposed a steeper reduction of allowances each year in line with more ambitious 2030 emission reduction goals, reducing supply even further. It also rejected any easing measures to the MSR. Estimates inevitably vary but analysts forecast a price of €86 by 2030 while the EU Commission forecasts a price of €85 by 2030.[[12]]

In addition, supply may be constrained further as a result of the EU Green Deal as well as the discussion among member states to cancel yet more EUAs in response to coal phase-outs.

These examples highlight how tightening emissions regulation may provide a positive catalyst for the performance of the EU carbon market.

Climate considerations among investors

The urgency surrounding climate change has led to investors across the spectrum seeking to incorporate climate considerations into their portfolios, both from an impact and financial perspective. Incorporating ESG has become a key part of broad investment strategies rather than a niche activity, and has a greater emphasis on opportunity-seeking, in line with the objectives of a transition to a low carbon economy. Examples include, the EU Climate Transition Benchmark (CTB) and Paris Aligned Benchmarks (PAB).

Social pressure

Increasing pressure on investors to act responsibly has already led to over $50tn of assets being publicly committed towards net zero goals.[[13]] More investors are looking for innovative ways to make good on these commitments and achieve environmental impact, which may lead to increased awareness and exploration of the carbon markets.

Recent eligibility of EUAs

The Paris Aligned Investment Initiative (PAII), which comprises four investor networks globally including the Institutional Investors Group on Climate Change (IIGCC) in Europe, has recently recognised physical carbon allowances as an eligible investment for net zero investing.[[14]]

However, EUA market access is too complex for many investors

For many investors, accessing the EUA market is challenging. One access route is to buy the EUAs outright. However, this requires a registry account, market access and the handling of a regulated digital commodity, creating a high level of operational complexity. Most real-money investors find the unconventional custody and settlement of EUAs very challenging. Furthermore, EUAs bought directly are not UCITS eligible.

EUA futures-based products (such as ETFs and certificates) exist but are associated with performance drag. This drag (known as “contango”) erodes the value of a futures-based investment over time, at the expense of the investor, and has recently been 50-130bps a year, but can be much higher.[[15]]

There are also environmental drawbacks to using futures-based products which do not necessarily remove EUAs from the carbon market, and therefore do not prevent polluters from using those EUAs to emit CO2.



EUAs outright


Futures-backed products

Operationally complex

Incurs roll costs / Performance drag

Unconventional settlement & custody

Does not withhold EUAs from polluters

Not UCITS eligible

Weaker environmental impact claim


SparkChange was founded in 2018 to solve these problems. The company has created the world’s first physically-backed EUA investment product that’s tradable on stock exchanges. This makes it easy to invest in physical EUAs and maximise the environmental impact of such an investment.

[1] $152.2bn according to NOAA

[2] WHO

[3] UNEP Gap Report 2020

[4] UNEP Gap Report 2020

[5] 85% of offsets failed to reduce emissions according to EU study

[6] By trading volume (Source: Refinitiv)

[7] Refinitiv

[8] EEX (EUR15.03 on 02.07.18 rising to EUR56.25 on 30.06.21)

[9] Refinitiv: Carbon Markets Year in Review 2020

[10] Based on Bloomberg data as at 1st Sept 2021

[11]Own calculations based on Bloomberg data as of 1st Sept 2021

[14] PAII Net Zero Investment Framework for Consultation

[15]Source: EEX settlement prices as 1st Sept 2020: Dec20 futures = €27.75, Dec21 futures = €28.11, or circa 1.30% contango for the year; as at 1st Sept 2021: Dec21 futures = €60.12, Dec22 futures €60.42, or circa 0.50% contango for the year