As governments around the world seek to curb and capture emissions — and more companies commit to net-zero goals — the carbon market is heating up. Investing in carbon credits is a cost-effective way to offset emissions that have not yet been eliminated through direct reductions.
For many investors, the timing has never been more opportune: carbon markets are expanding globally, but potential regulatory changes that might drive up the cost of carbon credits have not yet come into place.
Additionally, investors are increasingly recognizing the value of carbon credits as an asset class that isn't directly tied to traditional financial markets, offering a potential hedge against inflation and market volatility.
Carbon projects generate carbon credits that allow a purchaser to either offset carbon emissions or realize financial returns through the sale of these credits. Carbon credits are quantifiable and verifiable and carbon credit investments support projects that either reduce future emissions, such as renewable energy projects, or directly remove greenhouse gasses from the atmosphere, such as reforestation or biochar projects.
This direct investor support of carbon credit projects helps cover the project's initial costs and often, the investor receives carbon credits in return, which can then also be sold on the carbon market. Similarly, pooled carbon project investments aggregate capital from multiple investors to fund a portfolio of projects that can then generate carbon credits. Investors in these funds benefit from both the diversification of risk as well as professional management.
Investors purchase carbon credits with the expectation that their value will increase over time. The financial return on carbon credit investments can come from the sale of the credits at a higher price than the purchase or production cost. Additionally, certain types of projects featuring an array of co-benefits (such as biodiversity conservation or social improvements) or deemed high quality may attract higher prices.
Corporate net-zero commitments are fueling the demand for carbon credits. As companies commit to reducing their carbon footprints to net zero, they often look for effective ways to offset emissions that are currently unavoidable.
Setting and working to achieve ambitious net-zero goals can enhance a company's market presence, brand reputation and competitive edge. The carbon market offers a platform for companies to demonstrate progress towards their objectives while they develop long-term plans for direct emission reductions. Moreover, by investing in carbon credits linked to projects that also deliver social and environmental benefits, companies can showcase their dedication to sustainability and ethical business practices. With carbon credits sourced from a variety of initiatives, firms can diversify their impact portfolios and support a wide range of outcomes that reflect their corporate values and objectives.
Investing in carbon credits also makes good business sense. It allows companies to incorporate the cost of carbon into their financial and strategic planning. By securing carbon credits at today's prices, businesses can guard against potential future cost increases of carbon credits.
Carbon credit investments also provide a flexible and immediate mechanism for companies to offset their emissions while they work on deeper, structural changes to their operations and supply chains to reduce direct emissions. This trend is expected to continue as more companies commit to net-zero and as stakeholders increasingly hold companies accountable for their climate impact.
Both retail and institutional buyers are important players in the carbon market, but the scale of their purchases and strategic interests differ considerably. Retail buyers are individuals, small businesses or organizations looking to offset a portion of their carbon footprint. Often, retail buyers may not have large-scale emissions but still wish to contribute to environmental sustainability. Purchases by retail buyers are generally smaller in volume and buyers might purchase carbon credits to offset emissions from specific activities, such as air travel and events.
Retail buyers often buy carbon credits because they want to support specific projects, like reforestation or wind energy, or to claim carbon neutrality for specific goods or services. Retail carbon credit platforms can simplify the buying process, making it accessible to non-experts. They may offer pre-packaged offsets corresponding to common activities or straightforward calculators to estimate emissions and the number of credits needed for offsetting.
By contrast, institutional buyers are large organizations, corporations, governments, or specialized investment funds. These entities typically have significant carbon footprints and more complex sustainability and regulatory compliance burdens, and as a result, their purchases are usually much larger. Institutional buyers often have strategic reasons for purchasing carbon credits such as meeting regulatory requirements or fulfilling part of their public ESG strategy. Institutions often create partnerships with market players and project developers to create or support customized carbon offset projects.
Given the scale and strategic nature of their purchases, institutional buyers often conduct more extensive due diligence on the credits they buy. This includes verifying the additionality, permanence, and verification status of the carbon reduction or sequestration projects.
Nature-based Solutions (NbS) credits constitute almost half of the entire carbon market. This category includes forest-related projects, wetland and mangrove restoration, peatland conservation, and regenerative and sustainable agricultural practices. NbS credits are valued for often showcasing multiple ecological and social benefits.
Credits from Carbon Dioxide Removal (CDR) projects are on the rise, however, with investors expected to purchase more CDR credits in 2024.
Credits from CDR projects directly remove CO2 from the atmosphere and store it in a way that is secure over the long term. This category includes reforestation and afforestation projects, soil carbon sequestration, biochar, enhanced rock weathering and direct air capture with storage. These projects are increasingly in demand as companies seek ways to offset their emissions by contributing to tangible reductions in atmospheric CO2 levels.
While more than $1 billion was injected into early-stage carbon removal projects in 2023, experts say that at least an additional $400 billion in CDR investments is needed by 2030 to meet 2050 climate targets.
Frameworks and guidelines are crucial for ensuring the integrity, transparency and effectiveness of the voluntary carbon market. They establish clear standards for quantifying, verifying and reporting carbon reductions and removals, helping to build trust among buyers, sellers and other stakeholders. These frameworks often address critical issues such as additionality, permanence, leakage and double counting, ensuring that carbon credits represent real, measurable and additional climate benefits.
Standards such as Verra’s Verified Carbon Standard and Climate, Community & Biodiversity Standards, along with Gold Standard, play a foundational role in providing confidence to buyers and ensuring the voluntary carbon market functions effectively. By standardizing how projects are developed, verified and reported, these frameworks can help mitigate risks of fraud, greenwashing and other practices that could undermine the market's effectiveness and reputation.
Blockchain technology has the potential to significantly increase secondary market trading in the voluntary carbon market. By introducing greater transparency, efficiency and accessibility, blockchain can address many of the challenges currently facing the carbon market.
Blockchain's inherent transparency can help ensure that transactions are recorded on a public or permissioned ledger, visible to all participants. This transparency helps build trust among market participants by providing a potentially clear, unalterable record of carbon credit issuance, transfer and retirement.
Additionally, by facilitating faster and more secure transactions, blockchain can significantly improve the liquidity of carbon credits. Tokenization of carbon credits can allow for fractional ownership and easier transferability, making it simpler for small and large investors alike to trade credits. Higher liquidity can also help make the market more attractive to a broader range of participants, potentially increasing trading volume on the secondary market.
Blockchain can also help streamline the process of verifying, transferring and retiring carbon credits, reducing the need for intermediaries and the associated costs and complexity. The use of smart contracts on blockchain platforms can help automate the trading and settlement process, allowing for real-time transactions. This immediacy can make the market more dynamic and responsive, further encouraging secondary market trading.
Tokenized carbon credits represent an innovative approach to buying, selling and trading carbon offsets using blockchain technology. In this system, carbon credits are converted into digital tokens that can be traded on a blockchain platform. Each token typically represents a specific amount of carbon dioxide emissions that have been reduced or removed from the atmosphere, often measured in metric tons. By tokenizing carbon credits, the process aims to enhance transparency, liquidity, and accessibility in the carbon market, leveraging the inherent benefits of blockchain technology.
Blockchain can enable the integration of carbon credits with other financial markets too, making it possible to create new financial products and services based on carbon assets. This integration can attract institutional investors and financial services firms, further increasing secondary market trading volumes.
In short, because the global carbon market is heating up: December 2023 saw the most credits retired ever in a month (37 million), capping the full-year total at 164 million, up 6 percent from a year ago.
Global awareness and action on climate change are at an all-time high, leading to stricter environmental regulations and increased corporate commitments to sustainability, which in turn drive demand for carbon credits.
The anticipation of rising carbon prices, as demand outstrips supply, suggests that timely investments in carbon credits could yield significant returns or cost savings in the future. The introduction of new standards for quality and verification are improving market accessibility and integrity, making it easier for buyers to participate and select credits that align with their sustainability goals.
Carbon credit investment is a proactive step for businesses and individuals looking to mitigate their carbon footprint, hedge against regulatory changes, and contribute to global climate action efforts.
