Carbon markets are nifty financial engineering, economists’ best stab at crafting a market-based solution to tackle climate change. They seek to price the future impact of today’s industrial emissions on our planet’s climate, shining a light on this hidden cost.
The concept is straightforward, but these units are tricky to value and exchange. Like the severity of climate change, the future cost to society of a ton of carbon dioxide is both unknowable and highly subjective.
There are two types of carbon markets: compliance and voluntary. Though their goals are the same—to price a ton of carbon— there’s a key difference in how the holders pay for carbon emissions.
Differente than Voluntary markets, Compliance markets, with their “cap-and-trade” programs, require companies in certain sectors to purchase permits in order to pollute.
These markets also offer two different types of securities:
Carbon credits, represent a holder’s right to emit one ton of carbon dioxide. Firms that want to pollute must purchase a carbon credit before emitting.
Carbon offsets, to counteract carbon emissions after they have been released in the atmosphere.
According to Morningstar, voluntary markets gain traction by convincing individuals and companies to take accountability for their emissions, and so far, they have grown at a consistent 45% clip. But building consensus is slow going. According to the World Bank, carbon offsets canceled out just 352 megatons of CO₂ equivalent in 2021.compared to more than 8,590 megatons of CO₂ equivalents per year in compliance markets, making them the de facto pricing mechanism for carbon.
Click on the graph below to read this great financial article by Morningstar about carbon markets, including the discussion of answers for the following three questions:
How We Assessed Carbon Markets?
Which Carbon Credits Programs Are Most Effective?
Can the Efficacy of Carbon Credits Programs Be Improved?
