As public concern over climate change grows, governments have sought to positively incentivize businesses to cut down on their greenhouse gas emissions. Governments have creatively devised a “cap-and-trade” system where high emitters are punished and low emitters are rewarded. Through cap-and-trade systems, governments set a cap on overall domestic carbon dioxide emissions. They can then distribute “carbon emission allowance credits” to companies, essentially telling each company how much carbon it is allowed to emit. However, if a company emits less than its allowance, it can sell its extra credits to other companies who are generating in excess of the regulatory caps. Thus, having the right approach investment management, carbon credit trading helps companies that care about the environment to make a profit.
What Are Carbon Credits?
A carbon credit is the unused portion of the emissions allowances granted by regulatory agencies. As tradable commodities, carbon credits are measured in metric tons. A company that is short one metric ton of emissions from its allowable maximum has 1 carbon credit to offer to another company.
Carbon Credits vs Carbon Offsets
Voluntary vs Compliance Markets
Compliance Carbon Markets
Compliance with carbon credit prices is a result of government policy. The government will dictate maximum emission limits, and issue carbon credits, and then unused carbon credits can be traded on compliance carbon markets. The compliance markets are also known as Emissions Trading Systems (ETS). The three major Emissions Trading Systems internationally are:
- European Union’s Emissions Trading System
- California Global Warming Solutions Act
- Chinese National Emissions Trading System
European Union ETS
The European Union ETS was the first ETS created, and it has operated since 2005. It is the most liquid carbon futures exchange and covers over 27 EU states. The EU carbon futures market is up over 1,400% in the last 5 years. In total, there are 10,569 power plants and manufacturing facilities which participate in the EU ETS, with a collective commitment to achieve net-zero greenhouse gas emissions by 2050. The EU ETS has collected $80.7 billion since its inception.
California’s ETS has been active since 2012. There are 330 registered entities participating in the ETS, equating to more than 550 facilities. Each is committed to achieving carbon neutrality by 2045. California ETS has collected $14.24 billion since it began.
The China National ETS began in 2021 and its jurisdiction covers all of China, operating on the Shanghai Environmental and Energy Exchange (SEEE). The power sector is currently the only sector regulated in the China ETS, however, the ETS is expected to expand to seven additional sectors. There are currently 2225 registered entities that participate, with a pledge to achieve carbon neutrality by 2060.
There are other compliance credit markets such as the New Zealand ETS, the Korean ETS, the Japan ETS, the Canada ETS, and the Mexico ETS. However, these are not liquid markets so they are very difficult for an investor to gain exposure to.
How to Trade Carbon Credits
Before trading carbon credits, an investor should do thorough research on the commodity, the market trends, and the trading options available. An investor should keep in mind that there are inherent risks to investing in compliance carbon credit markets, including policy changes and geopolitical tensions.
One investment method is purchasing an ETF with the carbon market as its foundational asset. Therefore, the ETF will track the trends of the carbon market.
Another method for investing in the carbon credit market is trading carbon credit futures contracts. The basic premise of buying a futures contract is locking in a price for the underlying asset, and then later selling the contract for a profit if the underlying’s price has risen above the purchase price. Futures contracts exist for carbon credits just like they exist for commodities. In addition to trading futures, trading options on those futures yields extra maneuverability.
What Is e360 Power’s Role in Carbon Trading?
e360 Power boasts three seasoned traders with a collective experience of 70 years, who consistently gain optimal returns on investment for clients. Niche markets like renewable energy and carbon credits are our specialty. We have the resources and connections to tap into these nascent and difficult-to-access markets, combined with a careful approach to risk management. Each position is carefully analyzed and hedged before an action is executed on the client’s behalf.
Investors who desire a solid return on investment while also being cognizant of environmental, social, and sustainable concerns should consider getting in touch with e360 Power. Our investment firm based in Austin, Texas is ready to grow your assets while being environmentally-conscious.