The global carbon market opportunity

Over the last 70 years, economic growth has been tied to an enormous increase in fossil fuel consumption, agricultural expansion and materials extraction. Since 1950, global average prosperity has increased more than four-fold. Over the same time, as we have torn down forests, depleted soils and drilled beneath our oceans, fossil fuel use has risen from 20,000 terawatt-hours per year to nearly 140,000.

Now, our global economic model is undergoing a transformation. We are moving away from today’s Wasteful, Idle, Lopsided and Dirty (WILD) system, towards a new model. One in which growth is decoupled from extraction and is linked instead to the regenerative power of nature. An economy that is Circular, Lean, Inclusive and Clean. We call this the CLIC^® economy.

At Lombard Odier we believe this transformation will be underpinned by an emerging new investment opportunity that could soon rival major commodities for size – carbon markets.

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a carbon blanket.

The level of carbon dioxide and other heat-trapping gases in the earth’s atmosphere is higher now than it has been for at least four million years. Driven largely by the burning of fossil fuels and deforestation, this build-up is accelerating. Since the beginning of the Industrial Age, atmospheric carbon dioxide concentrations have risen 50%¹ – half of this rise has come in just the last 30 years.

The impact of this growing carbon blanket on global temperatures has been stark. In 2017, human-induced warming breached 1 degree Celsius above pre-industrial temperatures for the first time. From 2013 to 2021, the world experienced nine of the ten hottest years on record. And in 2022, China’s 70+ day heatwave became the most extreme heat event in recorded history.

Global efforts to keep warming to 1.5 degrees Celsius – in line with the Paris Agreement – are under severe threat.

challenges

1.7trn

tonnes of CO₂ emitted by fossil fuels and industry since 1850²

50%

rise in atmospheric CO₂ level since the start of the Industrial Age³

1tonne

of CO₂ emitted for every passenger on a roundtrip between London and New York⁴

a cornerstone.

Today’s WILD economy is predicated on a massive market failure – the exclusion of the environmental cost of carbon emissions and other externalities from the price of goods and services. In omitting this cost – for carbon emissions true cost estimates range between USD 51 per tonne and USD 124 per tonne – producers and consumers have been sheltered from the downstream impact of their decisions, and incentivised to follow a linear take-make-waste economic model.

By including the price of emissions in the cost of doing business, companies are incentivised to adopt low-carbon technologies and adapt their working practices

Carbon markets can correct this failure. By including the price of emissions in the cost of doing business, companies are incentivised to adopt low-carbon technologies and adapt their working practices. Over time, consumers see prices shift in favour of an economic model that re-uses and recycles more and emits and discards less.

Today’s carbon markets provide proof of the concept. Between 2005 and 2019, following the introduction of the EU’s Emissions Trading System (ETS), carbon emissions in the bloc fell by 35%⁵. Over the same period GDP grew 42%, demonstrating that growth need not be accompanied by increased emissions. The European Commission described the EU’s ETS as “a cornerstone of the EU’s policy to combat climate change,” and its “key tool for reducing greenhouse gas emissions.”

Carbon markets in the Eastern United States and in California have seen similar success, with carbon emissions reductions of 47% and 26% respectively. ETSs have since followed elsewhere. In 2015, South Korea became the first emerging economy to launch a nationwide carbon market. In 2021, China launched a national ETS covering the power sector – now the world’s largest ETS, covering 7% of all global greenhouse gas emissions. And, also launched in 2021, a global market-based measure now covers carbon emissions from most international flights.

opportunities

17%

of carbon emissions already covered by carbon markets⁶

900bn

USD traded in carbon markets annually⁷

35%

decrease in EU carbon emissions since introduction of European Emissions Trading System⁸

compliance and voluntary.

In compliance carbon markets, such as the EU’s ETS, regulators set sectoral or economy-wide caps on emissions and create a permit for each tonne of allowed emissions. Businesses must own sufficient permits to cover their emissions or face heavy fines. With the supply of permits reduced year-on-year, the cost of emissions rises, incentivising high-emitting companies to adopt low-carbon technology and rewarding low-emitting companies through lower costs and by allowing them to sell surplus permits.

Increasingly, carbon credits are used to fund natural climate solutions that reduce emissions or store carbon by preserving and restoring forests, grasslands and other habitats and ecosystems

Voluntary carbon markets have seen strong growth in tandem with growing corporate action towards net-zero business practices. Voluntary markets help companies achieve their climate goals through the non-compliance purchase of carbon credits. Each credit in a voluntary market represents a unit of emissions “reduced”, “avoided” or “removed”. Increasingly, carbon credits are used to fund natural climate solutions that reduce emissions or store carbon by preserving and restoring forests, grasslands and other habitats and ecosystems.

the role of investors.

At the COP26 conference of November 2021, policymakers delivered a significant new set of rules that will allow carbon markets to interact across borders, potentially unleashing trillions of dollars of sustainable investments. The combined value of global markets for government-issued carbon allowances, backed by legally-binding requirements, has grown by 44% since 2019, to reach a record USD 172 billion last year. Projections point to a USD 1 trillion market cap by 2030, comparable with the current market cap of silver.

Investors will help to develop this burgeoning international carbon marketplace by contributing to price convergence across national and regional marketplaces. And by providing additional pools of capital they will support liquidity and price stability and predictability, enabling emitting companies to better plan their decarbonisation strategies over time.

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our strategy.

The global average price of carbon must rise about five-fold by 2030 and seventeen-fold by 2050 if we are to meet the Paris climate goal. This implies an average compound annual growth rate across existing markets of between 22% and 35% between now and 2030.

The global average price of carbon must rise about five-fold by 2030 and seventeen-fold by 2050 if we are to meet the Paris climate goal

For investors, carbon instruments offer a unique set of benefits. They are a natural hedge against the adverse effects of climate policies on the earnings of many companies; many carbon markets contain in-built mechanisms to protect against inflation; and by offering returns with low correlation to major asset classes they can be used to diversify portfolios.

Yet, globally, portfolios are almost universally short carbon. Few investors take into account the real and serious risks that the climate transition brings, and many are exposed to the risk of a sudden carbon price “squeeze” should regulations and climate commitments tighten.

…we aim to capture the most attractive risk/return opportunities in this new set of assets that we believe will underpin the transition to a CLIC^® economy

For investors, a detailed knowledge of the market is essential. Investing in carbon instruments entails navigating governmental, economic, and reputational risks, in addition to understanding the disruptive potential of new technologies. Through our careful monitoring and analysis of market, policy and technological developments, including through our proprietary Climate Value Impact framework, and with the employment of a flexible, actively managed strategy, we aim to capture the most attractive risk/return opportunities in this new set of assets that we believe will underpin the transition to a CLIC^® economy.

The sustainability transformation will disrupt 95% of our investment universe. High-integrity carbon markets represent powerful mechanisms for investors to support the transition, and will be the cornerstone of what we believe is a once-in-a-generation investment opportunity.

where we are.

Our heritage is Swiss, yet our outlook and mind set are resolutely international. With over 25 offices globally, we are able to serve our clients all over the world.

private clients.asset management.technology for banking.external asset managers.

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¹Carbon dioxide now more than 50% higher than pre-industrial levels | National Oceanic and Atmospheric Administration (noaa.gov)
² CO2 emissions - Our World in Data
³Carbon Dioxide | Vital Signs – Climate Change: Vital Signs of the Planet (nasa.gov)
⁴ICAO Carbon Emissions Calculator
⁵The EU Emissions Trading System in 2020: trends and projections — European Environment Agency (europa.eu)
⁶unlocking-the-potential-of-carbon-markets-to-achieve-global-net-zero-full-report-consolidated-vfinal1.pdf (gfma.org)
⁷Carbon markets: Invest in greenhouse gas emissions – Credit Suisse (credit-suisse.com)
⁸The EU Emissions Trading System in 2020: trends and projections — European Environment Agency (europa.eu)

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the global carbon market opportunity.

let's talk.

a carbon blanket.

a cornerstone.

compliance and voluntary.

the role of investors.

net-zero insights.

sign up to our newsletter.

our strategy.

our expertise.

where we are.

get in touch.

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let’s talk.

let’s talk.

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