Explaining carbon markets and the investment opportunity – an interview with our experts

    Explaining carbon markets and the investment opportunity – an interview with our experts
    Lorenzo Bernasconi - Head of Climate and Environmental Solutions, Lombard Odier Asset Management (USA) Corp

    Lorenzo Bernasconi

    Head of Climate and Environmental Solutions, Lombard Odier Asset Management (USA) Corp
    Callum Lee - Portfolio Manager, Lombard Odier Asset Management (Europe) Ltd

    Callum Lee

    Portfolio Manager, Lombard Odier Asset Management (Europe) Ltd

    In November 2022, Lombard Odier Investment Managers launched a strategy designed to seize the opportunities presented by global carbon markets. This latest offering in the alternative assets franchise is founded on the Bank’s CLIC® framework, which offers investors sustainability-based returns.

    We believe that the carbon markets will play a central role in accelerating the global economic transition towards a more sustainable future. Explore our global CO2 strategy with Lorenzo Bernasconi, Callum Lee and Ruben Lubowski from our Climate and Environmental Solutions Team at Lombard Odier Investment Managers.


    How do carbon markets work?  What is their objective? 

    Carbon markets are a tool for achieving cost-effective reductions in greenhouse gas emissions. By putting a price on carbon, and creating a financial value for emissions reduction, carbon markets encourage investments and business models that favour cleaner technologies and practices.

    The global carbon market is, in reality, two markets – regulated carbon offsets and voluntary carbon offsets – which together are estimated to be worth close to USD 1 trillion. In regulated markets, businesses must buy and surrender government certificates to cover each tonne of CO2 emitted as a result of their activities. A predetermined number of certificates are put up for auction by governments each year. This number is then reduced over time to limit availability and make pollution more costly. Businesses that do not comply must pay a fine that is significantly higher than the price of a certificate.

    The European carbon market successfully reduced electric power sector emissions by 43% between 2005 and 2021

    What makes this concept so smart is that it puts a cap on total pollution and leaves it to the market to find the most effective way of reducing emissions. Regulated markets have proved to be highly successful – for example, the European carbon market succeeded in reducing the electric power sector’s emissions by 43% between 2005 and 2021, without any adverse impact on GDP growth. This success has driven strong market growth over the past few years.

    Read also: ‘Net-zero economic growth’ need not be a contradiction

    The voluntary market operates on the basis of carbon-removal projects. In nature-based carbon removal projects developers often buy or lease land for planting trees with the aim of reducing the quantity of carbon in the atmosphere. They then apply for a credit corresponding to the CO2 reduction achieved over the period concerned. These credits may then be sold to investors, who can ‘offset’ the credited carbon reductions against their own emissions in order to achieve their climate objectives. The voluntary market is primarily intended for businesses committed to ‘net zero’, who currently represent an economic strength of USD 38 trillion in terms of stock market capitalisation1. This market will also play an increasing role in meeting country commitments under the Paris Agreement. Driven by these trends, the voluntary market is growing apace. In addition to its role in reducing emissions, the market is also important due to its on-the-ground role in preserving some of the world’s most ecologically-essential ecologies – it is the key to mobilising the necessary funding for nature conservation and restoration.


    What are the factors to be considered when it comes to the future of carbon pricing?

    We have extensive modelling expertise and apply a quantitative and probability-based approach to predicting the price of carbon. In other words, we conduct a fundamental modelling analysis, before examining the various political scenarios and market catalysts in order to formulate our short and medium-term price projections. We also benefit from the expert research provided by Lombard Odier – such as the Climate Value Impact (CVI) analyses, which provide a highly granular view of future emissions and reduction solutions – which is then fed into our models.

    Read also: The unexpected portfolio – a holistic approach to investing for net zero


    How are the risks associated with carbon market investment managed? And what are the most common risks that investors should be aware of? 

    A number of risks need to be factored in when investing in carbon. The first is the possibility that governments might cut back their climate change efforts. There is also the risk presented by economic factors, such as a major recession, that might affect demand for carbon credits as a result of lower industrial production. Diversification is the key to managing these risks. Our strategy draws on an extensive investment universe in terms of both markets and instruments and strategies, thereby minimising the impact of such risks. We have in-depth knowledge of the quality of the various standards applying in this area. We also analyse specific projects in conjunction with leading credit rating agencies.

    According to a recent study by the Boston Consulting Group, carbon markets could see a sixfold increase in size between now and 2030

    Read also: Putting an end to deforestation – starting local, going global

    How do you see the carbon markets evolving in the coming years?

    We believe that the carbon markets will continue to expand over the coming years – this growth will be seen particularly in new markets, such as China, South Korea and Australia. According to a recent study by the Boston Consulting Group, carbon markets could see a sixfold increase in size between now and 2030. We believe that the expansion of these markets presents significant opportunities for investors, given that these new markets will impose much more restrictive emissions caps. At the same time, we also think that the pressure exerted to achieve climate objectives will be a major driving factor. At present, carbon prices are negotiated at the global level and are well below the price required to achieve our current climate objectives, which are increasingly being enshrined in legislation. This highlights the need for a fivefold increase in the carbon price within the next few years.

    Finally, we also examine the impact that implementation of the Paris Agreement will have on the voluntary carbon market. Most countries are likely to make use of the carbon markets to meet their Paris Agreement commitments, and this paves the way to an exciting new carbon credits market which we intend to monitor closely.

    Read also: Challenge or opportunity? Rethinking hard-to-abate sectors


    What is so exciting about these opportunities? 

    Although the market has more than doubled in size since 2019, less than a quarter of global emissions are tied to a price. As the Lombard Odier 3+1 framework2 shows, carbon emissions pricing will be the key to achieving global ‘net zero’. Carbon markets and the creation of a CLIC® economy (one that is Circular, Lean, Inclusive and Clean) will be the most effective tools for achieving this.

    To date, carbon markets have consisted almost exclusively of participants that are compelled to use them – this has created inefficiencies. In addition, in many of the largest global economies carbon markets have barely seen the light of day. We think that they have the potential to increase significantly. These are perhaps the most exciting opportunities for investment presented by climate transition.

    Carbon prices on the principal markets have been one of the most profitable asset classes over the last five years

    Why should investors consider including carbon credits in their investment portfolios? 

    Firstly, there is the possibility of obtaining attractive returns. Carbon prices on the principal markets have been one of the most profitable asset classes over the last five years. They also have excellent advantages in terms of portfolio diversification thanks to their low correlation with other asset classes. Also, many carbon markets price in inflation protection – for instance, the carbon price cap in California has increased every year by 5% more than the consumer price index.

    Further, a number of analyses conducted in this area suggest that just a small allocation to carbon markets is sufficient to protect the rest of a global portfolio against the adverse financial effects associated with the global climate transition. Currently, most portfolios are primarily positioned to benefit from carbon in the short term and from climate change in the long term, which makes the addition of carbon a very attractive proposition.


    SBTI, May 2022: Companies committed to cutting emissions in line with climate science now represent USD $38 trillion in terms of the global economy - Science Based Targets
    2 Energy, land, oceans and materials.

    Important information

    This document is issued by Bank Lombard Odier & Co Ltd or an entity of the Group (hereinafter “Lombard Odier”). It is not intended for distribution, publication, or use in any jurisdiction where such distribution, publication, or use would be unlawful, nor is it aimed at any person or entity to whom it would be unlawful to address such a document. This document was not prepared by the Financial Research Department of Lombard Odier.

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