July 18, 2023

What is a carbon credit?

Learn about carbon credits, carbon credit investing and how they help solve the climate crisis.
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What is a Carbon Credit?

The basic idea of carbon credits is easy to understand - one carbon credit equals one ton of carbon dioxide that's either been prevented from going into the atmosphere or has been removed from it and put back in the ground.

Think of a carbon credit like a voucher - each carbon credit gives you permission to release one ton of carbon dioxide without adding to the amount of carbon in the atmosphere.

These credits play a key part in worldwide efforts by businesses to hit a goal known as net-zero emissions. What does that mean? It's when a company's activities don't add any more carbon dioxide to the atmosphere over the course of a year.

Companies usually reach this goal by reducing their emissions as much as possible, then using carbon credits to make up for any remaining emissions that are too hard or impossible to get rid of.

Here's where carbon credits become even more interesting. They bring the benefits of free trade to the challenge of cutting carbon emissions. Basically, a carbon credit is born when a project carries out an action that cuts or avoids carbon emissions. These actions can be anything from planting trees to using machines that can pull carbon dioxide out of the air.

These projects create carbon credits, which can then be bought by companies that want to cancel out their emissions. This is how these projects get the financing they need to keep running and for new projects to start. Once the reduction in carbon has been confirmed, carbon credits are handed out by organisations like Verra and Gold Standard. From that point on, they can be bought or sold based on whatever price people agree on.

But the journey of a carbon credit doesn't stop there. If you own a carbon credit you can choose to retire it, which means it can't be used again. When that happens, the retired credit is added to a company's carbon tally for the year, standing in for a ton of emissions that the company has offset. If a company buys enough carbon credits to match its total emissions for the year, it can claim it's achieved net-zero emissions.

Think of carbon credits as an efficient system for companies to invest in climate positive activities around the world, which otherwise wouldn't happen without this investment.

What are the different types of carbon credit?

All carbon credits represent one ton of carbon. But not all carbon credits are the same. Each one is linked to a specific project, and these projects can vary a lot in how well they work and the extra benefits they provide. To make sure everything is open and clear, it's important that we can track and check the activities and benefits of each project.

Some projects might provide extra benefits that line up with the United Nations' Sustainable Development Goals like helping to preserve wildlife or promoting gender equality. The year when the carbon emission was offset by a carbon credit, called its 'vintage', is also an important factor. Some companies like to use newer credits to offset their latest year's emissions. The changing effectiveness of projects over different years can also influence how much a carbon credit costs.

What are carbon credit registries?

While there are several registries that issue carbon credits, two of the biggest are Gold Standard and Verra. These registries check and confirm that carbon projects are legit and meet their standards for issuing carbon credits.

The cost of carbon credits can change a lot depending on the type of project they're linked to. Projects based on natural solutions like planting trees are usually cheaper to run, which is often reflected in their lower prices. On the other hand, credits linked to tech-based solutions are usually more expensive because of the higher cost of the required technology.

Investing in carbon credits

Although the main goal of carbon credits is to help reduce global carbon emissions, they also offer an interesting investment opportunity for investors. More and more, people see carbon credits not just as a tool for achieving environmental goals but also as a new type of asset with unique  benefits.

First, investing in carbon credits is a way to directly contribute to worldwide sustainability goals. When you buy carbon credits, you're essentially funding projects that reduce or remove greenhouse gas emissions. These can be things like renewable energy initiatives, tree planting programs or new carbon capture technologies. If you want your financial actions to reflect your environmental values, investing in carbon credits can be a powerful way to invest with impact.

The voluntary carbon market is also expected to grow a lot in the next few years. As governments and companies around the world commit to cutting their carbon emissions and hitting net-zero targets the demand for carbon credits has the potential to skyrocket. This growing demand combined with an undersupply of carbon credits could potentially push up the price of credits over time.

Carbon credits: An emerging asset class

Investing in carbon credits can diversify your investment portfolio. As a unique type of asset, carbon credits don't necessarily follow the same curve as traditional assets like stocks and bonds. This potentially makes them an effective tool for diversifying your portfolio and possibly boosting returns.

What's more, because each carbon credit is tied to a specific project investors can track and assess how well their investment is doing and the impact it's having.

However just like any other investment carbon credits come with their own set of risks and challenges. They might not be suitable for every investor. It's important to understand the carbon credit market, how it works, and its rules and regulations before investing. Keep in mind that the value of carbon credits can go up and down, and just because they've done well in the past doesn't guarantee they'll do well in the future.

At the end of the day, investing in carbon credits gives regular investors a unique chance to potentially both make money and have a positive impact on the environment. It combines financial planning and caring for the planet, reflecting the growing importance of sustainable investing in today's financial world.

The verdict

In summary, carbon credits are set to play a crucial role in our worldwide efforts to fight climate change. By pairing up those who emit carbon with those who offset it they allow for a market-based approach to reducing greenhouse gas emissions. They not only help companies hit their net-zero targets but also provide a concrete way for regular investors to contribute to environmental sustainability.

As a new kind of asset carbon credits offer a unique investment opportunity. They offer potential financial returns and the chance to diversify your portfolio. Investing in carbon credits can also combine personal investment goals with environmental stewardship, allowing investors to build a portfolio aligned with a positive long-term future for the planet. As we move towards a future where sustainable business practices and investments become the norm, carbon credits are set to play a bigger and bigger role in creating a greener, more sustainable world.

Just like any other market, the carbon credit market comes with inherent risks and all investors should thoroughly research before investing.

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