When a company reduces its greenhouse gas emissions, it can earn carbon credits which may then be traded to other companies which need to offset their own emissions. Individuals can invest in the carbon credit market in a few different ways, including direct investment in low-carbon companies, or via exchange-traded funds (ETFs).
The global carbon market is expanding quickly. The carbon commodities market increased from $270 billion to $851 billion between 2020 and 2021. The market is projected to reach $22 trillion by 2050.
Learn more about how to invest in carbon credits, and the pros and cons of this asset class, including portfolio diversification.
What Are Carbon Credits?
Carbon credits are a way of valuing or pricing how much a company is reducing its greenhouse gas emissions. Companies that directly reduce their own greenhouse gas emissions, including carbon (CO2) can earn credits for doing so.
These carbon credits can be valuable to other companies that aren’t able to meet greenhouse gas reduction targets. So they buy carbon credits from the companies that have them. Typically, companies that are in a position to sell carbon credits can make a profit. Each carbon credit represents one metric ton of carbon dioxide emissions. They are traded as transferable certificates or permits until they are actually used by a company and effectively retired.
For investors who are interested in ESG-centered strategies (i.e. companies that follow proactive environmental, social, governance policies) learning how to invest in carbon credits may be compelling.
What Is Cap and Trade?
An important dynamic to understand when deciding how to invest in carbon credits is the worldwide cap-and-trade market. Certain governments have put programs in place that place a limit or cap on the amount of greenhouse gases that companies can emit each year. Caps vary according to industry and company size.
Over time the cap can be reduced to force companies to invest in green technologies and reduce their emissions. Any emissions above the cap must be covered with the purchase of carbon credits (hence the term “cap and trade”), otherwise the company must pay a fine.
If a company is able to reduce their emissions, they can then sell those carbon credits to other companies, and make a profit on them. If they need to emit more than the cap, they buy additional carbon credits. As governments lower emissions caps, demand increases for carbon credits, and their price goes up.
Not every country has a cap-and-trade policy, but they have gained traction in the European Union, certain states in the U.S., the U.K., China, and New Zealand.
How Have Carbon Credits Become a Big Market?
For those interested in investing in carbon credits, consider this: Over one-fifth of global greenhouse gas emissions are now covered by carbon pricing initiatives, and even more are covered by voluntary carbon market purchases. This article focuses on the compliance carbon credit market created by governments, but it’s important to know the distinction between that and the voluntary carbon market.
In the voluntary market, companies choose to purchase carbon offsets as a way to cancel out their emissions. Carbon offset projects include emissions-reduction and removal initiatives such as tree planting and producing renewable energy.
In theory, this system allows certain companies to participate in the global system of reducing harmful emissions like carbon, even if those companies are still striving to attain low-emission goals in their own production or distribution systems. For example, some industries, such as cement and steel manufacturing, are unable to reach net zero emissions, so they can purchase carbon credits to help offset the emissions from their manufacturers.
3 Ways to Start Investing in Carbon Credits
Carbon markets are not as robust in the U.S. as they are in other countries, but this will likely change in the future. For now, there are a few ways investors can get started investing in carbon credits. This could be considered a form of impact investing.
1. Carbon Credit ETFs
An exchange-traded fund (ETF) is a pooled investment fund that tracks the performance of a certain group of underlying assets. There are carbon credit ETFs that track the performance of carbon markets. Some ETFs track a certain group of companies, while others track indices, futures contracts, or other asset groups.
2. Carbon Credit Futures
Another way to consider investing in carbon credits is through carbon credit futures contracts. Futures contracts are derivatives linked to underlying assets. A buyer and seller enter into an agreement to trade a particular asset for a certain price on a certain future date. With carbon credit futures, the underlying asset is the carbon credit certificate.
Carbon credits such as the European Union Allowances and the California Carbon Allowances have futures available on exchanges. However, carbon credit futures are complicated investments so they are only recommended for more experienced investors.
3. Individual Companies
A third way that investors can get involved in carbon markets is by investing in stocks of individual companies that generate or actively trade carbon credits. By investing in those companies investors can indirectly invest in carbon credits.
Other companies are investing significantly in decarbonization and decreasing their own carbon footprint. These are sometimes referred to as green stocks.
Also some companies have a business model focused on investing in carbon projects, so investing in those provides a targeted exposure to carbon credits.
Other Ways to Invest in Carbon Credits
There are also some newer private companies in the carbon credit space to keep an eye on. Although there isn’t a way for a retail investor to invest in private companies, it might be worth tracking these companies as they may go public in the future.
Additionally, new exchanges such as the trading platform LIBER have started offering retail investors exposure to portfolios of curated carbon credits. These credits may be grouped by region or by type, such as forestry or renewable energy projects.
💡 Recommended: 27 Ways to Invest in a Carbon-Free Future
Pros and Cons of Investing in Carbon Credits
While there are several benefits to investing in carbon credits, there are some risks and downsides as well.
Pros
• Profitability: Investing in carbon credits can be very profitable, and the market is predicted to continue growing in the coming years.
• Environmental and social benefits: Carbon pricing incentivizes companies to reduce their emissions, and as emissions caps tighten, and the price of carbon credits goes up, it gets more expensive for companies to pollute. By investing in carbon credits, investors can contribute to an emissions-reduction strategy that benefits both people and the environment.
• Easy to invest: Investing in a carbon credit ETF is just as simple as investing in any other ETF. Investors can gain exposure to carbon markets without directly trading futures or researching individual companies.
• Low supply and increasing demand: Currently there is a limited supply of carbon credits, and corporate demand for them is increasing. Companies are pre-purchasing them to cover emissions many years out, so their value is increasing.
• Weak correlation to equity markets: Carbon credits can be a good way to diversify one’s portfolio because they don’t have a strong correlation with the rest of the stock market.
• Price floor: Certain regions, such as Germany, are considering putting a lower limit on the price of carbon credits. This means their value could only go up from that price floor. California has a minimum carbon price that increases 5% plus inflation every year.
Cons
• Potential risks: Certain carbon credit ETFs track carbon credit futures, which can be volatile and risky assets. Also, the carbon credit market is relatively new, so there is a limited amount of past performance data to refer to.
• Narrow exposure: Carbon markets are limited to certain regions and are still a relatively small market, so investing in them doesn’t provide a lot of portfolio diversification.
• Limited environmental impact: Cap-and-trade policies are designed to limit corporate emissions and reduce them over time, but they are also essentially permits to pollute. Rather than reducing emissions, companies can simply purchase more carbon credits. Therefore, the actual environmental benefit of investing in carbon credits is limited.
• Not all carbon credits are the same: Some carbon credits are higher quality than others, and various factors go into determining their true value. It’s important to purchase through reputable ETFs or brokers to ensure the credits are legitimate and have value.
Risks and What to Watch For When Trading Carbon Credits
Investing in carbon credits may be profitable, but all commodities markets, including carbon markets, come with some risks investors should be aware of.
Carbon credit futures are speculative and can be very volatile, so ETFs that track them come with associated risks. Additionally, carbon credit ETFs only provide exposure to markets that have cap-and-trade programs, such as Europe and California. Therefore, they don’t provide investors with a broad exposure to carbon markets.
Also, carbon credit schemes are created by governments, and there is a risk at any time that a government could intervene and change the program or reduce the price by increasing the cap.
For this reason, carbon credit ETFs can be a good way to diversify one’s portfolio, but aren’t necessarily a place where investors should allocate a large portion of their money.
Steps to Start Investing in Carbon Credits
As an individual investor the way to invest in carbon credits is through ETFs and other pools. There are a few simple steps to start investing in carbon credits.
Step 1: Open a Trading Account
The first step is to open a brokerage account that offers ETFs. There are easy to use online trading platforms, such as SoFi Invest, where investors can buy ETFs, stocks, and other assets.
Step 2: Research and Decide on a Carbon Credit ETF
There are several different carbon credit ETFs to choose from. The next step is to research and choose one or more ETFs to invest in.
Step 3: Invest
The final step is to invest in the chosen carbon credit ETF using the trading account. Once the purchase has been made, the investor can track the ETF in the same way they would track any other stock or asset in their portfolio. Historically, carbon markets have shown volatility in the short term but have increased over the long term, so investors should keep that in mind when deciding how long to hold onto their investment.
Is Carbon Credit Investing Right for You?
Investing in carbon credits can be a profitable way to get involved in a growing market and support the transition to a low-carbon global economy. Since their launch, carbon credit ETFs have increased in value. However, they do come with risks, and past performance is not a predictor of future performance.
If an investor is looking to diversify their portfolio, allocating a small amount to carbon credit ETFs may be one good option.
The Takeaway
Carbon markets are growing quickly and predicted to be a huge industry in the coming years. There are several ways for retail investors to get involved by investing in carbon credits. Carbon credits are generated by companies that are able to reduce their own greenhouse gas emissions over and above what the company itself may need. This puts the carbon-credit-generating company in a position to sell their carbon credits for a profit, to the companies that need to offset their own emissions.
This system has some pros and cons from an environmental perspective, as well as from an investing perspective. Does trading carbon credits truly reduce global environmental pollution? While that remains open for debate, what does seem clear is that the demand for carbon credits is only growing, which is likewise spurring the growth of some investments, like carbon credit ETFs.
If you’re looking to start building an investment portfolio, one great way is using SoFi Invest®. The online trading platform lets you research, track, buy and sell ETFs, stocks, and other assets right from your phone. You can get started investing with just a few dollars.
FAQ
How do you make money with carbon credits?
Carbon credits increase in value when demand for them increases and supply decreases. As regulated emissions caps decrease, demand increases, as does price. Investors can make money with carbon credits by purchasing carbon credits and selling them when their market value increases.
How much does it cost to buy a carbon credit?
By investing in carbon credit ETFs, investors can gain exposure to carbon markets with a small amount of capital. The value of an individual credit fluctuates based on various market factors.
How much is an acre of carbon credits worth?
The market price for carbon credits ranges from under $1 to over $150. The per-acre rate that suppliers make depends on the type of land and project as well as the current carbon credit market rate.
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