Carbon Credit Trading Work
Carbon credit trading allows companies to reduce their greenhouse gas emissions without taking action themselves. One carbon credit is equal to a metric ton of CO2 or other greenhouse gases reduced, avoided, or removed from the atmosphere. These credits can be used by companies to offset their own emissions or buy into projects that lower CO2 levels elsewhere in the world.
While carbon credit trading has been around for decades, it is gaining momentum over the past decade. This is largely due to a growing number of corporate net-zero targets and interest in meeting international climate goals spelled out in the Paris Agreement.
The carbon.credit market includes both regulated and voluntary markets. In the regulated market, the underlying emissions reductions are verified through carbon offsets or Certified Emission Reductions (CER). This is done using an independent third party verification process. The resulting credits can then be traded on exchanges or over-the-counter in bilateral deals. The price of a carbon credit depends on its quality and the specific characteristics of the project. The varying attributes of credits, however, make it difficult to match buyers and sellers.
How Does Carbon Credit Trading Work?
As a result, the regulated market is still hampered by limited liquidity and fragmented risk management services. The quality of credits can also be an issue, as accounting and verification methodologies vary. Additionally, the underlying projects of many credits generate other benefits, known as ‘co-benefits’, which are not always fully captured by the credit.
In the voluntary market, there is a lot of activity amongst companies seeking to meet their net-zero goals and those aiming for compliance with existing regulations. These activities take place in a wide variety of sectors, from energy to manufacturing and financial services. The market’s rapid growth in recent years is attributed to the increasing availability of low-carbon technologies and the increased awareness of the need to tackle climate change.
The voluntary market is highly heterogeneous, with a range of different types of carbon credits being traded in volumes that are too small to create reliable daily price signals. Standardizing carbon credits could help to reduce the amount of activity in these small markets and facilitate the development of liquid exchanges for carbon.
In addition, it would help match supply and demand more efficiently by allowing carbon brokers to focus their efforts on a few credit types and by creating an opportunity for investors to invest in high-quality credits that have been validated.
With a more stable and transparent market, the carbon market can continue to be a valuable tool for those looking to reduce their environmental impact. It can support the creation of clean and renewable energy sources, provide new opportunities for investment in carbon capture technology, and encourage other businesses to look at their own footprints and consider how they can be more sustainable. Christopher Blaufelder is a partner in McKinsey’s Zurich office; Cindy Levy is a senior partner in the London office; Peter Mannion is an associate partner in the Dublin office; Dickon Pinner is a senior partner in the San Francisco office; and Jop Weterings is director of environmental sustainability, based in Amsterdam.
