Carbon credits are certificates or permits that allow companies to emit a certain level of carbon. But how do you invest in them, and do they have a positive impact on the environment? This article will answer all your questions.
Scientists worldwide have spent the latter part of the last century issuing warnings and explicit predictions about the effects of climate change on the global population. Still, most people didn’t think much of their warnings more than unfathomable numbers on a computer screen.
However, that’s not the case anymore. In the last decade, people around the world are witnessing the effects of climate change themselves.
From facing the hottest months in our planet’s history to watching natural organisms migrate and reproduce prematurely because of the warmth, climate change manifests itself in disastrous ways.
Amid this havoc, businesses are striving to save their reputations by creating environmentally productive policies centered upon reducing carbon. Similarly, impact investors are rushing towards the profit potential presented by such enterprises.
Some examples include Microsoft, which aims to be carbon negative by 2030, while Starbucks strives to store more carbon than it emits up till 2030. But, becoming carbon negative or even neutral is not easy for all companies.
That’s where carbon credits come in. So, what is a carbon credit? And does investing in carbon credits actually leave an impact? Read this article for all the details.
Table of Contents
What Are Carbon Credits?
Carbon credits are tradable certificates or permits that let an organization limit its carbon emissions or other greenhouse gas emissions to a specific amount. For example, if a company has a single carbon credit, it is allowed to emit one ton of carbon into the atmosphere.
Now, do carbon credits help the environment? Yes, they do. Carbon credits were developed as a part of a cap-and-trade program that funded companies that could not become carbon negative immediately.
Through these carbon credits, private companies get double incentives to reduce their carbon emissions, which leaves a positive impact on the environment.
By reducing their carbon emissions, these companies cannot only refrain from purchasing further credits, but they can also sell their leftover credits to companies who need them and earn profit.
The overall intention of introducing this concept is to reduce the number of carbon credits available in the market over time so that companies look for innovative ways to curb carbon and greenhouse gas emissions.
How Much Is A Carbon Credit Worth?
I know what you’re thinking. If a carbon credit is nothing but a permit or certificate, how are investors worldwide buying carbon credits to diversify their investment portfolio?
You see, reducing carbon emissions is not easy for major enterprises. Especially companies that produce energy from fossil fuels. That’s why, if these companies fall under the cap-and-trade system, they will have to pay for the carbon they emit by buying carbon credits.
Now, when it comes to selling carbon credits, companies who succeed in emitting less carbon than the credits they own can sell their credits to those who need them.
Each carbon credit means the organization owns a single metric tons of carbon dioxide and has the right to emit harmful gases under this limit. This way, carbon credits become tradable assets for companies working towards reducing their carbon emissions.
The marketplace also incentivizes lowering carbon emissions by permitting the allocation, trading, selling, and buying of carbon credits among organizations.
Who Invented Carbon Credits?
If you’re still learning about impact investing strategies, the concept of carbon credits might seem new to you. Believe it or not, this concept’s origins go back to 1997 when it was first discussed d in Kyoto, Japan, during the United Nations Framework Convention on Climate Change.
Furthermore, the idea was put forward again in 2001, when countries like Germany, Japan, and Australia, among 191 others, ratified the cause. In this summit, the idea of a cap-and-trade marketplace, where financial incentives could increase carbon credits’ value, was put forward.
Recently in 2015, the carbon credits discourse further evolved with new policies to be implemented from 2020. The main goals included the proper integration of carbon markets and linking global trading schemes so that companies create more ways to lower their carbon emissions.
Currently, carbon credits are issued under the Kyoto Protocol. The system assigns a specific greenhouse gas quota that each country is allowed to emit. Further, every country can specify an allowance for one metric ton based o its Assigned Amount Units by the Kyoto Protocol.
This way, they can assign these single-metric ton carbon credits to companies and businesses in their companies to limit the carbon they can emit. Now, organizations are free to use their credits in any way they like for their profit, which encourages new ways to combat excessive carbon emissions.
Difference Between Carbon Credits and Offsets
Before I explain how to start investing in carbon credits and whether it helps investors create a positive impact, you’ll need to know the difference between carbon credits and offsets.
Carbon offsets also represent a single ton of greenhouse gases, but these vehicles are solely created to reduce carbon emissions rather than limit them to a certain quantity. Look at it this way. The surplus of tradable carbon credits a company has is a result of its own mechanisms to reduce emissions rather than resulting from specific carbon-reducing projects.
On the other hand, carbon offsets are used to fund initiatives that reduce carbon in the atmosphere like reforestation, tree plantation, and renewable energy. While carbon credits can only be traded in a cap-and-trade market, carbon offsets can be traded in an open stock market.
For example, if you’re striving for impact by reducing your personal carbon footprint, you can purchase carbon offsets to compensate for your carbon emissions through other carbon reduction projects.
How Are Carbon Credits Traded?
If you’re wondering how to buy and sell carbon credits, the trading process works in a pretty straightforward way. The carbon prices are mandated and regulated by the government, and organizations can only emit greenhouse gases according to the credits they own.
If a company exceeds the limit, it will need to purchase more carbon credits or offsets from the market. On the other hand, if its emissions end up lower than the limit set by its carbon credits, the company can generate revenue by selling carbon offsets.
Now, there is only a certain number of credits available in the market. These same credits exchange hands from one company to another, generating profits for each organization while encouraging others to reduce carbon emissions through their own efforts.
When the carbon trading market was in its first phase during the advent of the 21st century, the prices were relatively low as carbon credits were in surplus. It was easier to acquire credits from developing countries with minimal emission controls on their operations.
As the market moved towards its second phase during the year 2012, the level of carbon credits allotted to each country was cut sharply. Meeting these carbon emission requirements became a challenge for most enterprises, increasing the demand for carbon credits.
Naturally, the prices for carbon credits began to rise with the demand at this phase. In such cases, sometimes paying the mandated fine for exceeding limitations is more affordable than buying new carbon credits.
How To Invest In Carbon Credits?
If you’re an aspiring impact investor wondering where to buy and sell carbon credits for profit, I have explained the concept for you in this section. In the aftermath of the Paris Agreement, carbon credits trading has become one of the big businesses of the impact investment sector.
But does it deliver the intended impact? And should impact investors targeting a quadruple bottom line go for this investment vehicle?
Firstly, investors should consider that the carbon trading market has been a profitable investment venture since its advent. During its initial years, more than $10 billion worth of carbon was traded across the market.
With that amount of money going around, investors willing to contribute huge funds could easily create a stockpile of assets and sell them when the prices rise. The CEO of Climate Change Capital assured investors that this cause could make enough returns to match the profits from leading industries like infrastructure or real estate.
However, if you impact investor targeting impact along with financial gains, there are some considerations to make before you jump into the market. These considerations will help you decide whether the carbon offsets you invest in actually deliver the impact you strive for.
Factors For Evaluating Impact In Carbon Investments
First of all, the investment you go for should target additionality. This means whether or not your purchase of the offsets or credits matters.
For example, the company you’re buying credits or offsets for has already devised measures to reduce carbon emissions while being cost-effective. In this case, the company would have reduced emissions regardless of your contribution, which reduces the impact of your investment.
Secondly, you should look for durability and permanence in the carbon offset you invest in. The program should reduce carbon emissions for a long time; consider this in terms of the geological clock.
Let’s say to invest in farmland whose owner aims to reduce carbon emissions. However, later that farm goes into his descendants’ hands, transforming the land for commercial use that produces carbon. This means your investment was not durable.
Lastly, an essential aspect for impact investors investing in carbon credits to consider is leakage. Carbon leakage is the unintentional emission of carbon generated by a project initially designed to reduce carbon.
For example, if an offset funds an organization to reserve a forest from logging, it might indirectly increase logging at another location. This unintentionally increases carbon emission rather than diminishing it, and your investment would more or less go to waste.
That’s why, to make sure you place an impact by investing your funds in carbon credits and offsets, conduct all background checks and due diligence before parting with your money.
Advantages of Investing in Carbon Credits
There are numerous advantages of mandating carbon credits; the most significant of these is the reduction of acid rain in the US by decreasing the emissions of sulfur dioxide in the atmosphere.
Besides that, carbon credits are designed as tradable, exchangeable entities that create a sense of profitability and ownership. This makes them easier to implement than strict carbon restrictions and taxes.
Suppose the cap-and-trade system could be effectively implemented globally. In that case, the system has the potential to reduce carbon emissions significantly and help countries meet the requirements of the Paris Agreement.
Disadvantages of Investing in Carbon Credits
Remember, there are always two sides to a coin. Although carbon credits are highly beneficial for reducing emissions, they are not risk-free methods of investment.
The most evident reason for this is that a carbon credit is not a real, tangible entity in its origin. Additionally, carbon or any other greenhouse gases have no intrinsic value, which can justify the fluctuations in price and discount.
That’s why restricting these emissions and limiting them to a specific range is quite tricky for governmental organizations. To make the concept strong enough for trade, organizations have to strictly limit and regulate the emissions to make them tangible like any other investment asset.
Besides that, carbon credits are also given away for free to some companies, which leads to a drop in price with no positive impacts on the environment. Similarly, carbon offsets also target reducing carbon emissions in developing countries whose overall effectiveness is questionable.
The carbon credits investment marketplace is a rapidly evolving industry. Currently, the market is speculated to produce two innovative streams to reduce carbon emissions.
These include decarbonizing existing assets to promote more low-carbon alternatives and designing financial systems where financial gains and environmental profits work hand-in-hand.
While uniting carbon pricing methods globally is seemingly impossible, investing in carbon credits is an important way to meet climate change demands.
Frequently Asked Questions (FAQ)
What are Carbon Credits?
Carbon credits are certifications or tradable entities that permit companies to emit a specific amount of carbon into the atmosphere.
How to Sell Carbon Credits?
If a company reduces enough carbon emissions to have a surplus of carbon credits, it can sell them to other companies that need them. These sales can be conducted through the cap-and-trade marketplace.
How to Buy and Sell Carbon Credits?
Investors can buy and sell carbon credits through exchange marketplaces. Some of the most popular exchanges that allow carbon credits trading include the NASDAQ OMX Commodities Europe, PowerNext, European Energy Exchange, and European Climate Exchange.