As governments aim to cut down their greenhouse gas emissions, they face the challenge of devising systems to police their companies that pollute heavily. One approach is through negative incentives, punishing companies for not meeting emission standards. However, governments have also positively incentivized companies by rewarding them for innovatively reducing their emissions.
A historically successful system that combines both positive and negative incentives is called the cap-and-trade market, where environmentally-conscious companies can profit while high-polluting companies face penalties. A specific cap-and-trade market that governments employ to reduce their total carbon dioxide emissions is called the carbon credits market.
What Is a Carbon Credit?
A carbon credit is a certificate that allows its holder permission to emit one ton of carbon dioxide. Polluting companies are awarded these permits, the cumulative sum of which determines the company’s total emissions limit. Once the limit is reached, the company must buy extra credits if it wishes to emit more. The overall number of carbon credits is periodically reduced by the government each year in its effort to decrease the total amount of domestic greenhouse gas emissions.
Carbon Credit Incentives
If a company does not use up all its carbon credits, it is allowed to sell its excess credits to another company. In this way, companies can turn a profit through reducing emissions. As a result, there is an entire marketplace of carbon credit investments. The system enacts negative incentives to polluters, charging them for their extra emissions. But it also provides positive incentives to innovators, rewarding companies for cutting pollution and being environmentally responsible.
Renewable Energy Certificates
One environmental complement to carbon credits is a Renewable Energy Certificate (REC). RECs certify that their holder owns one megawatt-hour of electricity generated from a renewable energy resource (wind, solar, hydroelectricity, or others). Once the power provider delivers the clean energy into the power grid, it is provided with a REC that can then be sold on the market. A polluting company is then allowed to buy this REC as a carbon credit equivalent, to offset its emissions. Therefore, any REC holder is a participator in the carbon credit investment market.
Investing in Carbon Credits
Implication for Investors
Given the size and scale of carbon credit investment, it is an attractive investment for many investors. However, it can be daunting to figure out how to invest in carbon credits. It’s not as simple as researching the P/E ratio of a company or buying the ETF of a popular index. You may be asking, “How can I invest in carbon credits?”. Carbon credit investment can be done through carbon credit exchange-traded funds, carbon credit futures, or individual companies. Investing in carbon credits can be a potentially lucrative way of supporting the environment, however, it also comes with risk.
Futures in this sector can be very volatile, and carbon-credit ETFs only diversify a portfolio to a limited degree. Additionally, there are debates over the effectiveness of this program. In the United States, cap-and-trade programs only exist in California and a few eastern states. If consensus agreed that cap-and-trade markets are ineffective, or if a more sophisticated program were ever devised, the cap-and-trade market could be displaced quickly. Though the sector is certainly growing, investors would be prudent to approach it cautiously. If you are interested in learning more about carbon credits and carbon emissions, you can access information through e360power.com.