Why Do Companies Buy Trade Carbon Credits?

Companies Buy Trade Carbon Credits

Companies aiming to cut greenhouse gas emissions often are unable to eliminate all their carbon dioxide and other greenhouse gases, so some seek to offset their emissions by purchasing credits in the market for them. The voluntary carbon credit market has grown in recent years, and McKinsey estimates that buyers retired credits for some 95 million tons of carbon-dioxide equivalent last year, up from about half as many in 2017. This increase is largely due to a greater awareness of the need to curb global warming.

In this marketplace, buyers and sellers match up through brokers and retail traders, just as in other commodity markets. These traders purchase large portfolios of trade carbon credits, bundle them together and sell them to end buyers, typically taking a small commission for the service. Retail traders also buy credits directly from the supplier, which is often a community-based project, such as reforestation or a biomass project. These projects are often vetted by a respected standards organization, and each is subject to a set of rules that dictate the amount of CO2 the project will remove from the atmosphere over time.

These projects often are designed to provide other benefits, such as improved water quality and reduced poverty, in addition to the CO2 reduction potential. These additional social and environmental benefits can command a premium in the carbon market. They also are more difficult to verify, since the exact number of CO2 a project will produce is based on a complex calculation that depends on variables including weather, soil type and tree growth.

Why Do Companies Buy Trade Carbon Credits?

For this reason, many traders and investors prefer to deal with a standardized product such as an Emissions Reduction Unit (ERU), which has specific attributes that are agreed upon in core carbon principles. This approach can reduce risk and costs for both suppliers and end users, which makes it a popular choice among companies seeking to comply with regulations at the national or regional level.

A regulated market for carbon credits is set by “cap-and-trade” programs at the state and local levels, as well as some global initiatives. When a company participates in one of these programs, it must abide by limits on carbon dioxide emissions or face penalties, which may include fines or higher taxes on its operations.

In the regulated markets, sources are allotted a certain number of carbon credits that they can use each year to stay below their emissions cap, and they may purchase credits from other affected sources or from the general market to make up for emissions that exceed those limits. Sources can also bank their allowances, which allows them to sell or retire them later, and this creates a strong incentive for them to reduce their pollution more than required by the program, so that they can use those excess credits in future years. This is known as overcompliance, and it has been the driving force behind some of the fastest growth in the carbon market.