Carbon Credit
A Carbon Credit is a tradable certificate representing the right to emit one metric ton of carbon dioxide (or an equivalent greenhouse gas), used within cap-and-trade systems to put a market price on emissions.
Carbon credits exist within two parallel markets. Compliance markets are government-mandated: regulated entities such as power plants, refineries, and manufacturers must hold enough credits to cover their verified annual emissions. The largest compliance market in the world is the European Union Emissions Trading System (EU ETS). In the United States, the California Cap-and-Trade Program and the Regional Greenhouse Gas Initiative (RGGI) operate on similar principles.
Voluntary carbon markets allow companies and individuals to purchase credits outside of any legal requirement, typically to offset emissions they cannot yet eliminate and to make net-zero or carbon-neutral claims. Credits in voluntary markets are verified by independent standards bodies such as Gold Standard, Verra's Verified Carbon Standard (VCS), and the American Carbon Registry.
The price of a carbon credit varies enormously depending on the market, the vintage year, the type of project, and additionality — the principle that the emission reduction would not have occurred without the credit funding. Compliance credits in the EU ETS have traded above EUR 90 per ton, while some low-quality voluntary credits have sold for under $5 per ton.
For public equity investors, carbon credit exposure shows up in several ways. Utility and industrial companies with large carbon liabilities carry regulatory risk that increases as credit prices rise. Companies that generate carbon credits through reforestation, methane capture, or renewable energy development may have a hidden asset on their balance sheet. ETFs tracking carbon futures, such as those based on the EU ETS or California allowances, offer direct price exposure.
Greenwashing concerns have intensified scrutiny of voluntary market claims. The Integrity Council for the Voluntary Carbon Market (ICVCM) published its Core Carbon Principles in 2023 to establish a floor for credit quality.