Carbon credits. Man-made climate change advocates call them a way to make your green peace with the environment. Skeptics say they\'re a sop for wealthy, guilt-ridden greenies at best - and potentially fraudulent, at worst.

No matter what you think, these credits are probably here to stay. Read on as we cover this new market and what green investors should consider.

Paying for Pollution
Sometimes known as carbon "offsets", carbon credits are financial mechanisms that enable buyers to pay a third party to remove a quantity of carbon (in the form of a greenhouse gas) equivalent to what the buyer emits - in essence, neutralizing their own emissions.

Carbon credits are a burgeoning environmental and economic trend, particularly in the business world. In the U.S., carbon offset volumes, as measured by metric tonnage, grew by 100% from 2005 to 2006, and are expected to double again in 2007. An October 2006 study by the Conference Board reported that 75% of companies polled said they were "actively computing" their carbon footprints, while only 15% of the companies surveyed were actively engaged in carbon trading and 40% were considering it.

The Carbon Trading Markets
By and large, there are two types of carbon credit markets, one operating overseas and the other emerging in the United States.

Cap and Trade
In 1997, the U.S. Senate voted 97-0 to reject the Kyoto Protocol, which sets limits on the amount of greenhouse gases a country could release into the environment. Countries that did pass the Kyoto treaty now have set caps on greenhouse gas emissions. If a country emits less greenhouse gases than the cap calls for, it receives carbon credits that it can turn around and sell on worldwide carbon exchanges. If the country exceeds the Kyoto caps, it must buy credits to offset its extra energy use. The price of the carbon credits is set by the market.

Elective Carbon Credits
The U.S. has a voluntary carbon credit market, where companies and some individuals can buy carbon credits as offsets to the amount of energy they use. Thus, a well-traveled executive can offset the use of his gas-guzzling private jet by buying enough carbon credits to cover the environmental cost of the greenhouse gases emitted from his airborne travels, effectively making his impact on the environment negligible.

The Case for Carbon Credits
Simplicity
By paying a third party to remove a quantity of carbon from the environment, consumers can, in theory, achieve carbon "neutrality".

Awareness
The very existence of the carbon offset market, its fast rate of growth and the amount of media attention the market has received, has raised the visibility of the climate change issue. In a politically-charged environment, carbon trading is the most prominent agent of change on the global warming landscape. Corporations are leading the charge. Companies like Expedia (Nasdaq:EXPE), Orbitz (NYSE:OWW), HSBC Bank (NYSE:HBC) and Google (Nasdaq:GOOG) all have carbon trading programs up and running. Many more are in the pipeline.

It\'s Good Business
In the corporate sector, where most of the carbon trading activity is taking place, carbon offsets can be an attractive option, both fiscally and socially. Through efforts to better manage their greenhouse gas emissions, corporations can be rewarded by reduced costs through energy efficiency, superior brand positioning and public relations through carbon neutrality, and energized employees who support climate change initiatives. (To learn more about how going green affects companies, read For Companies, Green Is The New Black and The Green Marketing Machine.)

The Case Against Carbon Credits
No Measurement Benchmarks
One issue that has yet to be resolved in the carbon offset world is benchmarking, or establishing a certification or monitoring process that quantifies the real value of carbon trading programs. International standards bodies like the United Nations and global warming advocacy groups are trying to set up a system in which carbon credit buyers know that their investments are producing measurable results. For now, there is no uniform way to see that carbon credit companies are doing what they promise.

Distraction - Or Worse?
On one hand, the increased visibility of climate change as an issue is a boon to carbon credit supporters. On the other, it could also be a serious distraction - or even an impediment - to fighting global warming. If consumers surmise that they can pollute all they want, and have their polluting ways "forgiven" through carbon offsets, emissions could become a larger problem. (For related reading, see What Does It Mean To Be Green?)

Class Warfare
Carbon trading may make sense for some consumers, but they\'d have to be deep-pocketed ones. Currently, most carbon offset programs are skewed to corporate interests and to the wealthy. If a dockworker in Philadelphia wants to plant a tree in Uganda, the paperwork alone runs into the hundreds, if not thousands, of dollars. For working families, that\'s generally not an option.

Carbon Sham
One major concern that has come out of carbon credits, especially on the elective side, is the advent of carbon scams in which carbon credits are sold but no carbon reducing action is actually made. While increased regulation in this area will help, it is the ultimate responsibility of the purchaser to ensure that what is being promised is actually delivered.

Carbon Credits - Guidelines
The environmental group Clean Air Cool Planet has published a A Consumer\'s Guide to Retail Carbon Offset Providers. Inside, the group lists key questions potential carbon credit buyers should ask a carbon credit provider:
  • Do your offsets result from specific projects?
  • Do you use an objective standard to ensure the additionality and quality of the offsets you sell?
  • How do you demonstrate that the projects in your portfolio would not have happened without the greenhouse gas offset market?
  • Have your offsets been validated against a third-party standard by a credible source?
  • Do you sell offsets that will actually accrue in the future? If so, how long into the future, and can you explain why you need to "forward sell" the offsets?
  • Can you demonstrate that your offsets are not sold to multiple buyers?
  • What are you doing to educate your buyers about climate change and the need for climate change policy?

Conclusion
While many experts agree that putting a price on the cost of carbon is good, the need for having consumers and corporations trade potentially harmful environmental practices for carbon offsets is debatable. However, whichever side you are on, carbon credits offer a way in which individuals and businesses can reduce their footprint on the environment.

Related Articles
  1. Economics

    Understanding Organic Growth

    Organic growth is the increase in a company’s revenue and value due to internal operations.
  2. Economics

    Explaining Market Penetration

    Market penetration is the measure of how much a good or service is being used within a total potential market.
  3. Economics

    Calculating the Marginal Rate of Substitution

    The marginal rate of substitution determines how much of one good a consumer will give up to obtain extra units of another good.
  4. Economics

    Understanding Cost of Revenue

    The cost of revenue is the total costs a business incurs to manufacture and deliver a product or service.
  5. Stock Analysis

    5 Reasons Thoratec Corp. Keeps Impressing Investors

    Learn about Thoratec Corporation and its position in its industry. Understand five key factors why the company has impressed investors.
  6. Entrepreneurship

    Startup Analysis: How Much Is Palantir Worth?

    Learn about the private company Palantir, its valuation and how its valuation was derived. Understand how the company operates and if it deserves the valuation.
  7. Stock Analysis

    Jawbone: An IPO You Should Have on Your Radar

    Learn about the company Jawbone and how it has become successful with multiple product lines. Understand the benefits of investing in an IPO
  8. Economics

    What is a Free Rider Problem?

    In economics, the free rider problem refers to someone being able to get, for less or even for free, what others pay more for.
  9. Stock Analysis

    Startup Analysis: How Much Is Dropbox Worth?

    Learn about the private company Dropbox and how it operates. Understand the company's current valuation, how it was derived, and if it deserves it.
  10. Stock Analysis

    Startup Analysis: How Much Is Lyft Worth?

    Learn about the private company Lyft and how it has become a successful rideshare company. Understand its most recent valuation and if it is deserved.
RELATED TERMS
  1. Black Money

    Money earned through any illegal activity controlled by country ...
  2. Horizontal Merger

    A merger occurring between companies in the same industry. Horizontal ...
  3. Factor Market

    A marketplace for the services of a factor of production.
  4. Green collar

    A worker who is employed in an industry in the environmental ...
  5. Marginal Rate of Technical Substitution

    The rate at which one factor has to be decreased in order to ...
  6. Absolute Advantage

    The ability of a country, individual, company or region to produce ...
RELATED FAQS
  1. What is the utility function and how is it calculated?

    In economics, utility function is an important concept that measures preferences over a set of goods and services. Utility ... Read Full Answer >>
  2. What does marginal utility tell us about consumer choice?

    In microeconomics, utility represents a way to relate the amount of goods consumed to the amount of happiness or satisfaction ... Read Full Answer >>
  3. What is the difference between JIT (just in time) and CMI (customer managed inventory)?

    Just-in-time (JIT) inventory management focuses solely on the need to replenish inventory only when it is required, reducing ... Read Full Answer >>
  4. What are some examples of Apple and Google's best-selling product lines?

    There are many good examples of product lines in the technology sector from some of the largest companies in the world, such ... Read Full Answer >>
  5. What is a negative write-off?

    A negative write-off is a write-off conducted by a company or accountant after deciding not to pay back an individual or ... Read Full Answer >>
  6. How can tariffs cause inefficiencies in domestic industries?

    Any government regulation naturally creates inefficiencies in a pure supply and demand marketplace. When it comes to the ... Read Full Answer >>

You May Also Like

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!