How Can Carbon Credit Exchanges Be Traded?
Carbon Credit Exchanges Be Traded
If a company wants to reduce its carbon emissions, it can offset them by purchasing credits from a project that has reduced its own carbon footprint. This is known as “carbon trading.” The market for these credits can be broken down into compliance and voluntary markets.
A carbon credit is an allowance to emit a certain amount of carbon dioxide in a certain time period. It can be purchased, sold, or traded among companies within a framework of a cap and trade program that regulates the overall emission levels of a country. Similarly, a carbon tax aims to disincentivize businesses from engaging in polluting activities by increasing their cost base.
Some countries, including the United States, have their own carbon-trading schemes. For example, under the Kyoto Protocol, industrialized countries had to meet their target emission reduction goals and sell any excess to other nations in order not to exceed their emissions limits. However, the global economy has been slow to make substantial changes to its energy infrastructure, and there are still plenty of companies that haven’t met their emission targets yet. This means that many are looking towards the carbon credit exchange market to help them get closer to their goal and avoid costly penalties.
How Can Carbon Credit Exchanges Be Traded?
While most of these transactions are conducted in private conversations and over-the-counter, there are some specialized exchanges that facilitate carbon trading. The New York-based Xpansiv CBL and Singapore-based ACX are two examples. These carbon exchanges utilize blockchain technology to connect supply and demand through standardized contracts.
There are also a number of brokers and retail traders who link up the supply and demand for carbon credits, much like in other commodity markets. These brokers buy large amounts of credits directly from the supplier and bundle them together into portfolios that are sold to end buyers, typically with a commission attached.
Finally, there are standards, which are organizations that create a set of methodologies to verify a specific type of carbon project. For example, a reforestation project will have to follow specific rules regarding its expected level of CO2 absorption over time in order to be considered valid. This is why it’s important for investors, stockbrokers, and other financial players to understand the different types of carbon credits before entering the marketplace.
As the carbon-trading market continues to grow, clear demand signals will be crucial in ensuring a resilient and robust market for carbon credits. This will require reference contracts with defined attributes that will allow for high volumes of trades. This will allow for the development of a sustainable platform for carbon markets and provide businesses with the incentives they need to make serious efforts in their sustainability programs. McKinsey’s Christopher Blaufelder, Cindy Levy, Peter Mannion, Dickon Pinner, and Jop Weterings contributed to this report. The views expressed are those of the authors and do not necessarily reflect those of the firm. All investments involve risk and losses may occur. This information is not intended to be investment advice, and should not be treated as such.
