Myth one: There is no regulation with carbon credits – how do you know a tonne of carbon is an actual tonne of carbon?
It is important to note not all carbon is created equal. In the case of voluntary carbon offsets, the market is bespoke, and each tonne can be different. This means that transparency and scale is likely to take much longer to develop versus the growth we’ve seen in carbon compliance markets.
Compliance carbon markets, also known as regulated markets, are markets in which a regulator sets a limit (or “cap”) on the number of emissions the economy can emit each year based on their emissions targets. This cap reduces each year and incentivises the reduction in carbon emissions annually.
There are two types of compliance carbon markets: cap-and-trade (allowance) markets and cap-and-offset markets. Australian carbon credit units or ACCUs are regulated by the Australian government and are heavily scrutinised to verify that a tonne of carbon is a tonne of carbon.
Myth two: Carbon credits allow the big emitters to ‘offset’ their way out of the transition
Establishing functioning carbon markets and setting a price on carbon like a commodity will incentivise large polluters to make the changes to their business. Put simply, the higher the cost of carbon the more likely that big emitters will pursue other options to meet their net zero obligations – disavowing businesses from simply “offsetting” their way to meet targets.
Unquestionably, big emitters will still need to use carbon credits to offset some of their operations, but it will be done in conjunction with changing business practices to lower carbon solutions.
For carbon markets to facilitate allocating resources away from emissions-intensive activities towards emission removal and reduction, markets need to be liquid, transparent, and a tradable asset class.
By buying and holding carbon certificates, investors create liquidity, price discovery, and improve overall market efficiency. With greater market efficiency comes more effective capital deployment into new technology and projects that directly abate or sequester carbon, accelerating the global process of decarbonisation.
Second, an investment into carbon credits will increase the market demand, pushing up prices. As carbon credits become relatively more expensive, there is an increased incentive to find and invest in emission reduction technology and projects. Successfully doing this will mean less CO2 in the atmosphere and the company will have to purchase relatively less carbon credits as they would be emitting less CO2.
Third, the delay gives more time to reduce emissions in areas where carbon abatement is more difficult.
Myth three: Investing in carbon does not meaningfully contribute to net zero
There are many ways that investors can support net zero:
- Investing in high-emitting companies and changing behaviour from within through shareholder activism.
- Investing in impact strategies which omit exposure to carbon-intensive companies.
- Investing in long-term renewable projects through private equity and other channels.
- Incorporating a carbon credit strategy.
The first three strategies each come with their own unique opportunities. Engaging with companies directly can be difficult for medium or small investors and often involves long lead times to realise meaningful change. Exclusion strategies can cause tracking errors to market indices and can sometimes see assets transferred into the world of private capital. While deploying capital in renewables in an increasingly competitive market delivers investors limited diversification and again often requires long lead times.
However, portfolio diversification is critical with any investment strategy and different approaches should be considered, particularly as the pace of the transition accelerates. Carbon allowances, far from being a disregarded option, should be recognised as a suitable vehicle for diversification within investment strategies.
As we progress towards a decarbonised future, carbon credits will remain a crucial component of the overall strategy. They will continue to serve as a mechanism for maintaining emission reductions and reinforcing responsible practices even after successful decarbonisation.
By embracing carbon allowances as an integral part of investment portfolios, we not only safeguard against future uncertainties but also contribute to driving sustainable practices across industries. In essence, the synergy between emission reduction, carbon credit utilisation, and strategic investment holds the promise of a more environmentally conscious future and the possibility of enhanced financial security.
Luke Donovan, partner, global carbon markets, Apostle Funds Management
