A closer look at the carbon market
Carbon credits and carbon offsets are often used interchangeably, but that isn’t quite accurate. Carbon credits refer to an entity’s ‘right’ to emit one tonne of carbon, whilst a carbon offset represents the amount of sustainable energy produced, emissions reduced, or the amount of carbon captured by a sequestration project to ‘offset’ the use of fossil fuels.
In addition, carbon credits are only traded on cap-and-trade markets, whereas anyone can purchase carbon offsets from a non-profit organisation or emissions reduction project. For example, some airlines allow customers to buy carbon offsets equivalent to the amount of CO2 produced on their flight when they book their ticket.
The theory underlying carbon credits is relatively simple. A carbon credit equates to the prevention of 1 metric tonne of carbon dioxide prevented from entering the atmosphere through a certified climate action project. These climate action projects remove, reduce and/or avoid GHG (greenhouse gas) emissions.
These projects frequently have multiple positive benefits, and often work to reduce dependence on fossil fuels, protect ecosystems, promote reforestation, and empower poorer communities. Entities in heavily industrialised countries (organisations, businesses, companies, manufacturers and individuals) can offset their carbon emissions by buying carbon credits from these certified projects. Thus, one entity (usually an entity that finds it difficult to reduce its own emissions) is able to benefit from another entity that has managed to reduce its emissions. In doing so, there is overall less CO2 emitted to the atmosphere. Important to note is that cnce a carbon credit has been bought, it can’t be reused or bought again.
What do carbon credits cost?
The price of carbon credits fluctuates, as they are primarily driven by the levels of supply and demand in the market. Carbon credits are bought and sold on specialized exchanges like the NASDAQ OMX Commodities Europe and the European Energy Exchange.
They also differ depending on the country of origin. For example, according to goldstandard.org, carbon credits from wind projects based in India (which are in abundance) sell at an average of $1.2/tonne compared to those originating from the US, which typically sold for $3.7/tonne.
What is more, if larger volumes are traded, the price may be lower. As a rule of thumb, voluntary carbon credits, VERs, tend to have lower prices than credits sold via a regulated or compliance system, CERs, regulated by the Clean Development Mechanism.
It’s important to note that because annual caps on emissions are shrinking, the demand for and cost of carbon credits is skyrocketing. This makes them an interesting opportunity for forward-thinking investors.
- The aim of carbon credits is to lessen the amount of carbon that enters the atmosphere. Carbon credits are a market-centric mechanism aimed at achieving this ultimate goal.
- Entities are allotted a specific number of credits which lapse with time.
- An entity can sell any excess credits to another entity.
- Cap-and-trade are regulatory government programmes to limit, i.e. ‘cap’, the level of emissions of specific chemicals, most notably carbon dioxide.
- In order to encourage entities to find more innovative ways to reduce GHG emissions, the number of carbon credits available will be reduced over time.
- By paying another entity to reduce their emissions, companies can ‘lighten’ their environmental footprint as they work towards achieving a carbon-neutral position.