How Carbon Credits Are Priced

The price of carbon credits is a reflection of the economic value of reducing greenhouse gas emissions (GHG) and the impacts that these reductions have. This value is reflected in the cost of the carbon credit itself as well as the cost of the benefits that the project provides. Typically, high quality credits are more expensive to purchase. The reason for this is that projects delivering more societal impacts (such as community economic development or biodiversity preservation) usually require more complex accounting, verification and management systems. These projects also face longer lead times to market and are often more vulnerable to speculative buying.

To determine the true costs and benefits of carbon.credit projects, organizations should follow a four-step framework that looks at the project’s impact on natural capital. This framework begins with identifying the risks and opportunities associated with a project’s activities. Then, they need to assess the costs and benefits of restoring natural capital by considering the following:

While the four-step framework can be applied to any type of activity that impacts natural capital, it’s particularly useful for companies looking at how to price their carbon credits. This is because carbon credits are sold in a regulated and voluntary market with prices based on different methodologies and factors.

In a regulated market, called an emissions trading scheme or ETS, governments set a limit/cap on the amount of GHGs that can be emitted. Businesses are then alotted an allowance to emit this amount and can trade the unused portion of their permits with other businesses that need more. The money collected from these transactions is used to fund activities that reduce the emission levels in the market.

This type of trading system is the most common for pricing carbon credits, and is known as a cap-and-trade system. It is a popular alternative to imposing taxes on GHG emissions, as it encourages innovation.

While this type of trading system is effective at reducing emissions, it may not be as efficient as a carbon tax. A carbon tax is an essentially a flat fee per ton of GHG emissions and thus can be much simpler to implement. However, it has been criticized for being unfair to poorer economies, driving up the cost of energy and discouraging investment in clean technologies.

Voluntary markets, on the other hand, are open to anyone who is willing to pay for a carbon credit. While there are a number of advantages to this type of carbon market, it is difficult to quantify and standardize the benefits. There is also a risk of unsustainable trading and uncertified projects. In addition, the market is largely driven by supply and demand, with few safeguards to ensure that the prices reflect actual economic values. Despite these challenges, there are signs that the market is maturing and that buyers and suppliers are beginning to align their values with the price of carbon. This includes the increasing emergence of financial actors to provide capital and to hedge risk, standardized transactions, and the use of Blockchain technology to increase buyer access to the market.