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Any completely new market – for spices, mass-produced consumer goods, esoteric AI software, or novel financial products – is bound to be a little turbulent at first. It takes a while for ground rules to be laid down and mechanisms put in place to establish a fair value for an unfamiliar commodity.
Fortunately, retail investors can easily learn how to invest in carbon credits, ETFs that invest in these, and individual companies that are linked to renewable energy. However, exercising some caution is advisable.
Explore what carbon credits are and whether the market, largely dominated by institutional investors, might be an attractive investment option for individual investors.
Key Takeaways
- The main purpose of carbon credits is to shift the damage a company does to the atmosphere from an externalized to an internalized cost.
- Businesses now have to pay for the right to pollute above a certain level.
- Both voluntary and mandatory emissions markets exist.
- While there are some opportunities to be found in the voluntary carbon market, compliance-oriented ETS is more transparent.
- Carbon credit trading is dominated by institutional investors.
- Most individuals prefer simpler investments like holdings in carbon-neutral or low-carbon stocks.
What Are Carbon Credits?
Today, over 200 countries, together responsible for 98% of man-made greenhouse gases, each sets an annual quota for the amount of carbon they’ll inject into the earth’s atmosphere. This total is then divided among different companies operating within their borders.
A carbon credit, also referred to as a carbon allowance, is a permit that authorizes its holder to release a specific quantity of carbon dioxide or its equivalent in other greenhouse gases. Each credit permits the emission of one ton of GHGs.
Buying carbon credits, even compared to investing in financial derivatives, is a somewhat abstract exercise. However, there is a firm legal framework for carbon credit trading and the concept does make sense once you understand the background.
Essentially, starting around 1992, it became apparent to decision-makers worldwide that mitigating climate change would require a transnational effort. In order to spread the burden around fairly, and because the vast majority of carbon emissions are produced by industry, a system was needed to correlate tons of CO2 to dollars and cents. In 2016, the carbon credit was born.
Certain industries regularly exceed their allotments. In this case, they can buy carbon credits, each representing the right to emit one ton of carbon dioxide, from less developed nations or cleaner enterprises.
Green Initiatives
Some “green” companies have also figured out how to sell carbon credits they generate, for example, by financing sustainable agriculture initiatives.
Several companies – Ford, Microsoft, Apple, Amazon, Walmart, and many others – have realized the branding benefits of being carbon-neutral and plan to attain this status in the coming years.
In May 2024, Google, Meta, Microsoft, and Salesforce formed the Symbiosis coalition, an alliance meant to scale natural carbon removal.
The coalition aims to accelerate the development of high-impact, science-based restoration projects that will advance progress on global climate goals.
Melanie Nakagawa, Chief Sustainability Officer at Microsoft, said:
“High-quality, nature-based solutions are vital to addressing climate change, and our work with the Symbiosis Coalition is a key step towards realizing our carbon negative goal by 2030 through a diversified portfolio of carbon removal. This collaboration will help build the overall market for these solutions, leading to more restoration purchases that benefit all of us. Continued investment in carbon removal is important not just to meet our goals but for the world to meet its goals.”
Two Main Types of Carbon Markets
However, as reforestation and renewable energy development projects aren’t exactly their core business, though, businesses effectively outsource these functions by participating in the Voluntary Carbon Market (VCM).
The VCM is not administered by a single authority, making it difficult to determine the amount of money that changes hands (though the figure is certainly much lower than that of the mandatory market).
Each exchange also applies its own auditing standards; so, while it’s easy to figure out how to buy carbon credits from multiple sources, comparing their actual ecological impact is far from straightforward.
The Emissions Trading System (ETS) is more formalized, better regulated, and more liquid, accounting for over $60 billion in carbon credit trading annually.
Transactions take place on several national and regional exchanges, the largest of which is the EU Emissions Trading Scheme. Plans for a global, unified exchange have not yet borne fruit.
Based on the “cap-and-trade” principle, the supply of carbon allowances is restricted on a countrywide level, with heavy fines levied on companies that exceed their quota. This offers some price support to retail investors willing to learn how to invest in carbon credits for profit and not just as a public service.
Carbon Markets Comparison
How to Invest in Carbon Credits: 3 Avenues for Retail Investors
With some online trading platforms, you can buy a fractional share in a company for as little as $1 in under 5 minutes.
Sadly, if you’re interested in learning how to buy carbon credits, there’s no comparable system that lets retail investors take part as easily.
Still, anyone can get involved in both the voluntary carbon market, the mandatory ETS, or analogous investments if they wish.
1. Carbon Mutual Funds & ETFs
Certain specialty funds invest the bulk of their funds in both carbon credits and low-carbon businesses. If the price of emission allowances rises, carbon-neutral stocks should follow suit.
Carbon credit ETFs tend to be fairly volatile: the total market can be expected to increase over time, but it’s probably not going to be an entirely smooth road.
Some funds are much more diversified than others, though, and may include a conservative mix of bonds issued to finance sustainability initiatives, large-cap stocks, and more speculative investments. In addition, many are also willing to buy carbon credits as such.
Here are the top five carbon trading ETFs for 2024 to gain exposure to the carbon emissions markets:
- KraneShares Global Carbon Strategy ETF (KRBN): This tracks the IHS Markit Global Carbon Index. It offers exposure to carbon allowances across major cap-and-trade programs like the European Union, California, and others. It’s one of the largest and most diversified carbon credit ETFs available.
- KraneShares California Carbon Allowance Strategy ETF (KCCA): This is focused on the California carbon market, which is one of the most established regional carbon markets in the world. It tracks the IHS Markit Carbon CCA Index.
- Global X Carbon Credits Strategy ETF (NTRL): This ETF offers diversified exposure to global carbon credit futures by tracking the ICE Global Carbon Futures Index, covering various emissions trading schemes worldwide.
- iPath Series B Carbon ETN (GRN): This ETN is designed to reflect the price of carbon through futures contracts on EU carbon credits. It is one of the oldest products in the carbon trading space.
- HANetf SparkChange Physical Carbon EUA ETC (CO2): This ETF provides exposure to European Union Allowances (EUAs) by physically backing the carbon credits, offering a direct link to the European carbon market.
These ETFs provide a diverse set of strategies for investing in carbon credits, going from global exposure to more regional focuses, as well as catering to different risk appetites.
2. Green Companies
Not knowing how to invest in carbon credits directly doesn’t have to stop you from diversifying your portfolio into sustainable, low-carbon stocks.
These may include:
- Companies known to buy carbon credits to offset pollution arising from their normal operations
- Those selling allowances created by improving sustainability
- Renewable energy businesses that stand to gain from any increase in the carbon price
- Platforms that facilitate carbon credit trading
3. Carbon Credits Futures & Options
As with foreign currency and commodities, it’s often desirable to set a firm price for carbon credits in advance of April 30 each year, when each company’s carbon contribution is weighed against its quota and purchased credits. This means that emission futures and options contracts can be traded on the open market; these work in much the same way as their equivalents based on stocks and commodities.
Indices to watch include:
The EUA Carbon Futures Index (ICEEUA) and US Carbon Futures Index (ICEUCBN), containing futures like XICEH25 due in March 2025 and XICFU30 for completion in 2030.
How to Buy & Sell Carbon Credits: Risks & Rewards
Individuals are at a disadvantage in the emission markets compared to corporations and institutional investors.
Carbon offset projects, like forestry initiatives, tend to be large and negotiated directly between the two parties involved; they aren’t generally repackaged into smaller units retail investors can afford.
There are indeed some ways to gain exposure to this rapidly growing market. Investors who are principally interested in returns should approach this asset class with caution, though.
While technically anyone can join in – and vehicles like futures contracts do exist, you could easily find that you don’t know how to sell carbon credits you were once sure of being able to unload.
Investing in carbon stocks and carbon credit ETFs requires less knowledge of what is still an immature and sometimes chaotic market.
Still, these assets remain susceptible to shocks like regulatory changes and technological innovations, making them a riskier prospect versus more traditional investments.
The Bottom Line: Should You Invest in Carbon Credits?
In terms of its intended ecological purpose, the carbon credit trading system is a long way from perfect. However, it has played a key role in reducing greenhouse gas emissions in recent years.
From a retail investing perspective, buying a company stock, fund, or futures contract should still depend more on its finances than its environmental credentials.
In years to come, the emissions market will almost certainly become more democratic. For the moment, though, it can be tough for retail investors to figure out how to buy carbon credits directly.
Carbon credit ETFs, fortunately, are a close substitute and allow you to determine the amount of volatility you feel comfortable with.
The information in this guide does not constitute investment advice and is meant for informational purposes only.
FAQs
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References
- Greenhouse Gas (GHG) Emissions | Climate Watch (Climatewatchdata)
- Global Climate Agreements: Successes and Failures | Council on Foreign Relations (Cfr)
- Google, Meta, Microsoft, and Salesforce pledge to contract for up to 20M tons of high-quality nature-based carbon removal credits by 2030 | Business Wire (Businesswire)
- EUA Futures (Ice)
