Carbon is a term used to describe carbon dioxide (CO2) and other greenhouse gas emissions, which build up in our atmosphere and lead to climate change.

A new record reading for the highest daily level of carbon dioxide in the atmosphere was set in early May 2022, ringing alarm bells about the pace of global warming.

The daily record of 421.37 parts per million CO2 was recorded at Mauna Loa by the Scripps Institute of Oceanography, with similar numbers reported by the National Oceanographic and Atmospheric Administration.

What Is Carbon Investing?

Investors are increasingly looking to invest in ways that align with their values, which often include climate concerns. One way to do this is by investing in carbon credits. A carbon credit is a certificate or permit that represents a reduction in carbon emissions, with one credit representing one metric ton of carbon dioxide.

Companies that emit less than their permitted amounts of carbon can sell their excess permits on the market. While those firms that exceed their limit must purchase these carbon credits.

There are two types of carbon credit systems: voluntary and regulatory. 

In a voluntary system, companies use carbon credits to track their greenhouse gas emissions. The most common form of this system is called an “offset,” in which carbon credits are created through greenhouse gas reducing practices, such as planting a forest or running carbon-capture systems. However, there is no enforcement mechanism in a voluntary system.

A regulatory system is one in which a government issues carbon credits. A regulatory body will set a cap on how much carbon dioxide an industry or economy can emit in a given year then release credits meeting that amount. Companies can sell and trade these credits among themselves. This creates a private market for carbon emissions known as cap and trade; the government has capped emissions, but allows companies to trade those credits privately to determine their most efficient use. Once issued, credits do not expire.

However, this market is still in its early stages globally. These programs aren’t yet common in the U.S. as they are elsewhere (for example, Europe), but several states have joined regional initiatives to enact such policies.

Why Invest in Carbon Credits

There is no doubt the market for carbon credits is growing by leaps and bounds.

The Taskforce on Scaling Voluntary Carbon Markets forecasts that, in order to meet the climate change targets as set forth in the Paris Agreement, the voluntary carbon markets will need to grow 15-fold by 2030 – and 100-fold by 2050 – from 2020 levels.

That makes it a fast-growing asset class. According to Refinitiv, in 2021 the size of the global carbon market reached $851 billion, compared to only $270 billion in 2020. Wood Mackenzie, a commodities consulting firm, expects that the market could reach a breathtaking $22 trillion by 2050.

Carbon credits were one of the best-performing asset classes in 2021. 

The IHS Markit Global Carbon Index returned 108% in 2021. The index tracks the futures of the major global carbon markets including Europe, California (also tied to certain Canadian provinces), and RGGI (Regional Greenhouse Gas Initiative, which covers the U.S. states from Virginia up to Maine. The European Union carbon allowance (EUA) futures returned 138% over the year, California returned 73%, and the RGGI returned 68%. 

There is also a related asset – carbon offsets, of which there are two types.

An Avoidance Offset is a contractual agreement registered with an exchange that avoids pollution in the first place. Examples include paying landowners to not cut down trees or incentivizing farmers to not turn grasslands into crops. 

A Removal Offset is taking carbon out of the atmosphere through, for example, reforestation. 

However, there are not, as yet, many ways to invest in carbon credits and offsets (although there likely will be more in the future). With that said, here are a few ways investors can get started.

How to Invest in Carbon

One way is to purchase carbon-credit futures that trade on the Chicago Mercantile Exchange.

However, the easiest way is through a carbon-credit exchange-traded fund (ETF) that tracks the performance of the carbon market via carbon-credit futures contracts. There are now several of these on the market.

There is also a new ETF that tracks carbon offset futures contracts, which also trade on the Chicago Mercantile Exchange.

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The information and data are as May 18, 2022 (publish date) unless otherwise noted and subject to change. This blog is sponsored by Magnifi.