Interview with Michael Azlen, CEO of Carbon Cap Management

In 2018, Michael Azlen, a senior investment professional, began to research climate change and environmental investment, focussing on carbon pricing and Emissions Trading Systems (ETS). He is now the Founder and CEO of Carbon Cap Management, which aims to raise awareness about climate change and provide solutions directly related to the capping and reduction of carbon dioxide emissions.
22 Jul, 2021

What led you to found Carbon Cap Management?

After 25 years in the investment industry and 16 years as a guest lecturer on the London Business School’s graduate programme, I sold my asset management company and became deeply imbedded into research on climate change. In 2018, I enrolled in the climate change programme at the LSE Grantham Research Institute on Climate Change. This is where I learned about “Cap and Trade” Carbon Emissions Trading Systems(ETS), which have been one of the only successful policy instruments for addressing climate change. These ETS markets are now large and liquid: today trading more than $1 billion per day between across the cash and derivatives markets.

I wanted to analyse the properties of carbon as an asset class but quickly learned that the data was not readily available, so I hired a PhD student from the LSE and we constructed an accurate historical time series on multiple carbon markets and produced an academic paper analysing the returns, volatility and correlation of carbon. An extract of our research has been published by the CFA Institute. This proprietary research demonstrates that carbon exhibits very attractive returns, modest volatility and low correlation to other asset classes

Since the Paris Agreement was signed in 2015 and ratified in 2016, carbon prices have increased significantly, and in three of the past four global equities market drawdowns, carbon has been generated positive returns. The research led to the formation of Carbon Cap as an environmental asset manager with a mission to raise awareness of climate change and provide solutions directly related to capping and reducing emissions. We have launched the World Carbon Fund which has dual objectives of delivering uncorrelated absolute returns and a direct climate impact.

Over the course of the past 12 months what do you consider to be the most significant development in the markets you operate in?

The most significant developments in the carbon markets has been a growing global awareness of the need to increase climate ambition in order to reach Paris Agreement goals. Existing carbon markets are expanding and new carbon markets are launching with more than a dozen countries now considering the launch of their own carbon market. One of the biggest developments has been the launch this year of the Chinese carbon market covering more than 4 billion tonnes of annual emissions.

Last year the European Commission proposed a tightening of the EU’s 2030 emissions reduction targets and set a goal of at least 55% reduction below 1990 levels. The European Parliament then voted through an even stronger target of 60% below. The European (EU) ETS also entered its fourth phase, in which the market is tightened by default. The financial sector’s rising climate awareness has also led to a substantial growth of interest in the EU ETS by financial participants who are looking benefit from higher prices and/or to hedge climate policy risk inherent in their traditional portfolios.

In the US, the RGGI market has been bolstered by the reintroduction of New Jersey and the entry of Virginia. This expansion is also indicative rising societal focus on climate change and a growing recognition of the need for US state-led climate action even though the 2020 US election’s unprecedented focus on climate change and the Biden administration have promised decisive action on the issue. In the California Carbon market, structural issues have led to increasing calls by independent review committees and even the State Senate to increase the stringency of the market to deliver meaningful emissions reduction.

Looking ahead, what market developments do you anticipate?

Compliance carbon markets are established by policy makers to reduce emissions by creating a financial incentive to invest in lower emission technologies. As the price of carbon increases, so does the incentive to switch to new production methods. Economists calculate that in order to meet the Paris targets, the carbon price would need to rise significantly from current global average levels of $20 per tonne. Forecasts for the Carbon price required by 2030 range from $60 to $120 per tonne. This backdrop, which is likely to receive increasing support from policy makers, provides an attractive context for investing into these markets, which we anticipate will continue developing around the world as new countries launch ETS and as existing markets expand their sectoral scope.

For example, China’s National ETS began its launch in 2021 and a number of other countries are considering national ETS: Mexico is in its pilot phase and Colombia, Indonesia, Vietnam and the Ukraine have begun work. Similarly, we expect the further development of regional carbon markets, such as the Pacific Climate Alliance, the US state-led Transportation and Climate Initiative, and the likely medium-term linking of the UK’s new ETS with the EU ETS. Further down the line we predict that nations will increasingly seek to link their carbon markets as lower cost abatement opportunities get used up domestically.

What are the risk and return drivers in the carbon markets?

We believe that the outlook for carbon prices over the next decade is very positive. However, carbon markets can exhibit high volatility driven by a range of “market” and “policy” factors. Carbon markets are designed by policy makers to reduce emissions, and therefore policy decisions which change or update the rules of the market will affect the price. Some markets have a price cap or price floor, or supply adjustment mechanisms which allow the regulator to change the supply of carbon in response to market imbalances.

There are also a wide range of other factors which impact carbon prices over the short run such as economic activity, demand for energy, commodity prices, energy sources, technology developments, and additional policy features such as the rules governing free allowance allocation.

Over the longer term, three main drivers underpin a forward-looking risk premium.

• Policy: carbon markets are designed to stimulate emission reductions through higher prices. As the price of carbon rises, it stimulates companies to find low carbon solutions so policy makers, environmentalists and investors generally agree that they would like to see a higher carbon price.

• Structure: carbon supply is reduced each year. This makes carbon unique among commodities since the supply declines yearly by a known amount while demand, which is linked to economic growth, has the potential to rise.

• Increasing awareness: new scientific evidence and the increasing frequency and intensity of extreme weather events are driving increased awareness among policymakers and the public.

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