Carbon Credit Trading
A carbon credit is a trading unit that represents one metric ton of greenhouse gas emissions reduced, sequestered or avoided. carbon.credit are used by companies or individuals seeking to offset their own emissions or by governments in regulatory compliance schemes. One such scheme is a cap-and-trade system where a government limits overall domestic greenhouse gas emission levels and distributes credits to entities that can prove they have avoided or reduced their own emissions.
The other type of carbon market, which is not subject to a mandatory cap and trade program, exists in the voluntary sector where companies voluntarily seek to offset their emissions by purchasing credits generated by projects that reduce or eliminate their own emissions. The most common ways to generate carbon credits are through investments in renewable energy projects, through forest conservation activities, through reforestation initiatives, and through projects that capture CO2 from the atmosphere. These projects may also produce additional co-benefits such as increased welfare for local communities or improved water quality.
Currently, buyers of carbon credits connect to suppliers through brokers and retail traders, just like in other commodity markets. The brokers or retailers then bundle the credits into portfolios, ranging from hundreds to thousands of carbon credits equivalent to a certain amount of CO2 emissions, and sell them to end buyers, typically charging a small commission. While most of these transactions occur in private conversations and over-the-counter deals, some large carbon markets are forming on exchanges, such as the New York based Xpansiv CBL and Singapore based AirCarbon Exchange (ACX).
Carbon Credit Trading – current voluntary carbon market
In addition to being an essential part of any climate change mitigation strategy, carbon market activity also has the potential to create enormous revenue streams for innovative companies, particularly those that develop technologies that can reduce the costs of cutting greenhouse gases. For example, the electric car maker Tesla recently reported selling its carbon credits to traditional car makers for over $518 million in the first quarter of 2021.
Aside from the revenue potential, however, carbon markets have a number of other important characteristics that are critical for their success. For one, they must be designed to minimize transaction costs and ensure that the highest quality credits are available. As such, a robust infrastructure is required to enable the creation of a reliable market. This infrastructure includes resilient and scalable trading, post-trade and clearing functions, supply-chain financing, advanced data availability and a consensus on the legitimacy of offsets for corporate emissions claims.
The current voluntary carbon market is plagued with challenges, including inefficient trading and a lack of liquidity. This is largely due to the fact that credits are highly heterogeneous, each with multiple attributes that buyers value differently. To overcome this, it is necessary to establish a set of core carbon principles and standard attributes that can be applied to every credit. Once these are in place, exchanges such as CTX can then work to streamline the process of linking supply with demand by creating standard products for the most common types of credits.