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What is Carbon Credit Trading? A Beginner’s Guide

Want to be involved in Carbon credit trading? While it’s usually companies and sovereign governments that trade carbon credits, investors from the retail market are able to participate too. The trick is finding an accredited broker who can provide the possibility of carbon credits futures.

Below , we will review one of these brokers – who has a broad variety of other products as well as assets. We will also examine how large organizations trade carbon credits by taking the help of an expert carbon credit trading platform. In the end, we want to answer the most important question of how carbon credit trading function?

What is a Carbon Credit?

Carbon credits are evidence that proves that one metric tons (1000kg) in carbon dioxide is eliminated from the air.

The premise for carbon credit was Kyoto Protocol of 1977. Through this agreement the 192 nations agreed to cut carbon emissions and the value of carbon credits was established. The carbon credit was made an asset that can be traded.

What exactly is Carbon Cap and Trade?

A “cap and trade” policy developed in the wake of Kyoto Protocol. Kyoto Protocol.

The cap is the upper limit on carbon emissions every company is allowed to emit.
The business: businesses can offer carbon credits (if they have surplus limit of emissions from carbon) or purchase carbon credits to increase their limit.

Kyoto allowed four kinds of assets that could be traded:

AAU Assigned Amount Units carbon emissions.
RMU Removal Units that remove carbon due to the use of land or forest.
The ERU is the Emissions Reduction Unit – created through a joint implementation.
CER (Certified Emission Reduction) Certified Emission Reduction – created by a green development project.

Each asset corresponds to 1 metric tonne (1000kg) in CO2.

The carbon caps and trading was created as a means for companies to reduce their carbon emissions to comply to the Kyoto Protocol. The market then developed into a carbon credit exchange platform as investment assets. Retail investors are now able to trade carbon credits in the same way that they could invest in stocks with a broker like eToro or one of the top futures brokers.
Carbon Credits: A Timeline

1997. Kyoto Protocol legitimates the creation and trading of carbon credits.

2015 Section 6 of the Paris Agreement reinforces carbon credit trading between nations to meet their NDCs (Nationally Determined Contributions the carbon dioxide emissions). According to the International Emissions Trading Association (IETA) estimates that carbon trading in accordance with Article 6 could be saving nations $250 billion annually in 2030.

2021 2021: the Glasgow Climate Pact is signed at the United Nations’ Cop 26 (Conference of the Parties). One of the resolutions it passed is to establish the creation of a global carbon trading market for credit.

How do you define Carbon Capture? Sequestration?

The presence of carbon dioxide in the atmosphere has made the temperature in the world increase in a dangerous way – that’s the conclusion of the IPCC (Intergovernmental Panel on Climate Change). By the year 2200, the global temperature is expected to rise 4C higher. Scientists believe that this will lead to many areas of the planet becoming inhabitable.

5bn tons of carbon dioxide must be eliminated from the air each year, until the mid-century mark in order to limit the temperature increase to 1.5C.

“Carbon capture and sequestration” is a method of reducing carbon dioxide that circulates. This method is targeted at industry specifically. It involves the capture of carbon dioxide released by industrial processes, transferring it to storage, and then storage in a secure manner.

There are many other methods of reducing carbon dioxide that is emitted into the atmosphere are being explored and include:

Afforestation: Planting more trees.
Direct Air Capture (DAC) Removal of carbon dioxide (CO2) from atmosphere using machines.
BECCS: BioEnergy plus Carbon Capture and Storage.

What is Carbon Credit Trading Work?

Corporates can trade carbon credits by using an exchange for carbon credits similar to CTX that is described below.

For investors who are not retail, some online brokers offer the opportunity to invest with carbon credit. Through a broker such as eToro as an example trading carbon credits is similar to trading other investment assets.

Carbon trading credits are offered as Contracts-For-Difference (CFDs) or as carbon credit ETFs. The usage of CFDs implies that investors have two choices when signing up with the top CFD brokers:

They may choose to “go long’ which means to put money into the hopes of seeing the value go up.
You can also opt to “go short”, that is, put money into the hopes for a price decrease.

CFDs are also a way for investors to leverage their investment. This is basically using the money of the broker to boost the effect on the investment (which is known as the’margin’). Leveraged trading can be risky, and should not be considered for those who are new to investing.

A closer look at Carbon Credit Trading

In order to begin trading carbon credit, buyers have to be aware of one thing Carbon credits are typically sold as futures.

Carbon Credits Futures Trading

Futures are financial instruments which are priced based on what the market believes the value of an asset in the near future. Investors can now purchase futures contracts with the same ease as if they purchase Apple stock, for instance.

Some examples of carbon credit Futures comprise those offered by the California Carbon Allowance (CCA) Futures Contract, the European Union Allowance (EUA) Futures Contract and the Regional Greenhouse Gas Initiative (RGGI) Futures Contract.

Full-blown futures contracts can become complex. Therefore, it’s advisable for novices to stick with the basic overview provided by brokers such as eToro or invest in well-known Renewable Energy stocks.

Trading Carbon Credits with Carbon Trading – Simple 4 Step Process

The Investor:

Joins one of the brokers such as eToro and other brokers are also available.
Funds are deposited. With eToro as an example wire transfer, credit card and a variety of payment options are available.
It invests in carbon credits. With eToro carbon credits, they are available as one commodity. Investors must instruct the broker to either go either way’ or and eToro will then take over the assets on behalf of the investor.
The carbon credit can be sold. When the moment is judged to be appropriate then the investor can trade CFD CFD and return it to the broker with profit.

Risks associated with Carbon Credits Trading

The danger of emissions credits in the environmental standpoint is that the credits themselves are usually offsets. That means that somewhere in the future carbon dioxide will be taken out of the atmosphere. But the same firm that invests in this elimination could be producing carbon dioxide at the rate of knots.

For those who invest there are two major dangers associated with trading in carbon credits:

1. Price Volatility

As we can see in below the eToro pricing chart shown below carbon futures are equally high in volatility in terms of price as other commodities.

On the 22nd of August 2022, the cost was at $98 when it opened.
On September 16 2022 the cost was at $73 or less.
That’s a decline in value of more than 25% in just three weeks.
This fall follows a dramatic growth in the value by 22% from the 28th and 22nd July.

Any commodity investment – even carbon credits – ought to be balanced with investments in financial assets, which have lower risk and less price volatility. Investors could for instance purchase shares on eToro to offset their risk and also research ways you can invest in ETFs.

2. Uncertainty Over Regulation

The voluntary carbon credits market is split geographically and has various markets operating across Europe and the US and California with its own market. With no centralised market, there’s always the chance that investors are exposed to certain markets will go out of favor, and the prices will fall.

In the field of accreditation, many independent organizations are involved, which include:

Verra’s Verified Carbon Standard (VCS) located within the US, Verra is considered to be the best accreditation body. Verra has been responsible for having certified the removal of 630m tonnes of CO2.
Gold Standard has issued more than 125 million carbon credits derived from projects that span 60plus countries.
Climate Action Reserve (CAR) is an US organization that holds over 150 million carbon credits.

There are other accreditation bodies. It is also confusing that a lot of carbon offset projects and programs are promoted as being aligned with the UN Sustainable Development Goals. The result is a tangled mess of contradicting authorities.

The biggest risk for investors, especially large-scale investors is that accreditation organizations could lose their popularity and the credit they have granted will be less important.

Why should you trade carbon credits?

The motivation behind trading carbon credits is dependent on the person who is trading:

Governments of sovereign nations can begin meeting their climate change commitments through the purchase of carbon credits. Countries that have an advantage in environmental issues could offer their achievements to other countries by using carbon credits.
Corporate entities can purchase carbon credits to offset the carbon emissions from their businesses that are unavoidable. They can also earn profit by selling credits that demonstrate that their business is able to remove carbon dioxide from the atmosphere.
Retail investors are able to theoretically purchase carbon credits and keep them to offset their carbon footprint. It is however much easier to join an annual subscription to one of the many companies offering carbon offsets for consumers, such as Ecologi, CarbonClick, Climeworks and Wren.

In addition to trading carbon credits on their own Retail investors can take a look at the most popular ETFs for carbon credits. They offer exposure to the market for carbon as well as other ESG (Environmental Social , and Governance) commodities such as solar, clean winds, as well as geothermal power.

Similar opportunities are available with the popular sustainable investment funds.