In the spirit of Earth Day this upcoming Saturday, I thought I would provide a brief overview of the carbon market and some of the current measures being taken to reduce emissions.

 

Over the past few decades, countries have grappled with climate change and the need to reduce greenhouse gas emissions. One key idea that has emerged is to "put a price" on pollution to incentivize individuals and businesses to reduce their carbon footprint. In application, one of the main strategies has been the creation of "carbon credits."

 

Carbon credits are a market-based mechanism that allows companies (or even governments) to offset their carbon emissions by purchasing or investing in projects that reduce greenhouse gas emissions. They are a tradable commodity that can be bought and sold on carbon markets.

 

Carbon credits work because some emitters release more CO2 than their allowance permits (credit deficiency), and others release less than their allowance (credit surplus). Thus, the excess can be traded to companies that require more credits to meet their obligations. This dynamic creates the supply and demand aspect of the carbon market and incentivizes emitters to reduce their carbon emissions.

 

So, similar to traditional commodities, like Gold, Wheat, or Soybeans, these Carbon credits can be traded on exchanges.

 

This market is much larger than I had appreciated, with almost 20% of global emissions covered by various programs.

Carbon credits are traded in two types of markets:

 

1. Primary Carbon Markets: Primary Carbon Markets are the initial point of sale for carbon credits. These markets involve issuing and trading credit allowances by international organizations and governments to align with regulator/government-set emissions caps. Entities can then sell surplus credits to needy entities, while some regions allow regulated entities to purchase credits to meet obligations.

 

2. Secondary Carbon Markets: Secondary Carbon Markets allow market participants (i.e. banks and trading companies) to provide liquidity to regulated entities in a Cap and Trade program. Since increased liquidity supports price discovery, participants can hedge through carbon futures and derivatives.

 

For investors, there are now also funds that track the price of carbon credits among a myriad of environmental, social, and governance (ESG) considerations.

 

I have taken some time to learn about all this and would be happy to discuss or answer any questions you may have.

 

On a personal level, concerning the environment, I've started running into work a few times a week. It's too bad we can't "trade" our environmentally friendly actions for some of these carbon credits! I Hope everyone does something this weekend in recognition of Earth Day.