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Introduction
Many countries and some states have passed “cap-and-trade” regulations, which limit the
number of tons of CO2 a business can emit in a year. These tons are allotted as carbon credits.
Carbon credits are traded on the compliance carbon market.
When companies hit their emissions cap, they look to the compliance market to “trade”—
they’re trading money in exchange for another company’s credits.
Voluntary carbon market is a place where companies and individuals can, at their choosing,
buy carbon offsets to offset their carbon emissions.
There is a wide variance, however, in the price paid for carbon offsets, depending on project
quality, issuance year, verifiability, additional benefits created by the carbon offset, and other
factors. One major factor in pricing is the type of project. Different projects include forestry and
conservation, waste-to-energy projects, and renewable energy projects. Some of these projects
can be worth less than $1 per carbon ton offset, while others can be worth more than $50.

There are numerous online carbon exchange programs located both within the United States
and internationally that enable sellers to get cash for the carbon offsets they’ve produced. The
exchanges work the same way as various stock and commodity exchanges. The three largest
voluntary carbon registries in the United States have created standards for producing carbon
offsets. In addition, use strict protocols that both scientists and stakeholders have
implemented.

Primary Carbon Pricing Mechanisms

Carbon Tax
By taxing the institutions that emit CO2, governments can reduce those negative
impacts while also providing a revenue stream. A carbon tax isn’t perfect. As a pricing
mechanism, it’s fixed; adjusting a tax rate is a laborious and time-consuming process.
And there’s no real way to respond to market demand.
Emissions Trading System
Building a system for trading CO2 emissions establishes a rudimentary carbon market.
The market can set the price, at least within certain constraints. At the same time, an
ETS allows regulatory bodies to create a baseline price that increases over time –
incentivizing decarbonization.
There are at least two basic approaches to an ETS. A cap-and-trade program sets an upper
emissions limit and assigns carbon credits for emissions within those limits. Companies that
don’t use up all their emissions credits can trade their excess credits to other companies that
would otherwise exceed the limit.
Baseline credit systems use a similar process in reverse. Carbon credits are dispersed only to
companies that keep their emissions below a set baseline. Those credits can then be traded
with companies that are above the baseline.

Other Carbon Pricing Mechanisms

Internal Carbon Pricing
When companies calculate their own price for carbon emissions and build that into their
planning, that’s an internal pricing mechanism. Internal carbon pricing provides the
greatest flexibility for companies, but can also be the hardest to clarify or define.
Results-Based Climate Funding (RBCF)
Typically funded by various regulatory agencies or even non-governmental
organizations, RBCF offers payments when certain emissions reductions have been
reached.
Carbon Offsetting as a Pricing Mechanism
Carbon offsetting embraces a free-market approach to the carbon pricing problem. CO2
emissions are calculated by a ton of C02, but offsets are given for preventing or
removing CO2 emissions. Projects calculate the value of these offsets and then sell them
on the open market to other companies who want to cover some of their own
emissions. If every ton of CO2 produced by an entity is covered by an offset, then in
theory the net result would be zero emissions – what is commonly referred to as a “net
zero” position. Carbon offsetting lacks the regulatory oversight and control of some of
the other approaches to carbon pricing, such as government-run carbon policies.

But in exchange, it provides a wide range of flexibility. Carbon offset projects can be
highly technical CCS programs or focused on natural approaches. Example is restoring
natural carbon sinks like forests and peat bogs.

Examples of Successful Carbon Pricing Mechanisms

EU ETS
The European Union’s Emissions Trading Scheme is a variation on a cap-and-trade program. It’s
currently the largest carbon market, and a key part of the EU’s plan to tackle greenhouse gas
emissions. The EU ETS applies the same principle as most regulatory carbon markets, using a
slowly reducing cap on emissions to force companies to gradually reduce carbon output.
The market covered over 1.2 billion tons of CO2e in 2021 (The value of the global carbon credit
market reached ~$850 billion in 2021. A 164% increase from 2020.

California’s Cap-and-Trade
Regulated by California’s Air Resources Board (CARB), California’s cap-and-trade program is
one of the only ones of its kind in the United States. It’s also one of the largest in the world,
applying to several industrial sectors in California’s booming economy. Power generation and
fuel supply both come under the cap-and-trade program. The program began in 2013 and has
already achieved noteworthy goals such as the reduction of GHG emissions to 1990 levels.

Compliance Carbon Credit Market Overview

Compliance carbon credit prices are largely driven by government policy. Government strategy
will dictate maximum emission limits (otherwise known as allowances, or credits). Carbon
emitters buy or sell carbon credits based on emissions generated in relation to their allowance
limits. if they are under their emissions limit, they sell their excess allowances. If they are over
their limit, they buy to cover the shortfall.

Currently, there are three major Emissions Trading Systems around the world. They are:
 European Union’s Emissions Trading System (EU)
 The California Global Warming Solutions Act (USA)
 The Chinese National Emission Trading System (China)

European Union’s Emissions Trading System (EU ETS accounted for 90% of the global
compliance market. EU ETS jurisdiction covers the 27 EU states and 3 European Free Trade
Association states – Iceland, Liechtenstein, and Norway. The total GHG emissions in this
jurisdiction amount to 3,893 mega-tons (Mt) per year, making it the second-largest ETS in the
world.

The sectors regulated under the EU ETS during its first compliance phase were:

 Power stations and other combustion installations with >20MW thermal

rated input
 Industries including oil refineries, coke ovens, and iron/steel plants
 Operations that produce cement, glass, lime, bricks, ceramics, pulp,
paper, and cardboard
But there’s only one additional sector regulated during the EU ETS’s second compliance
phase:

 Aviation (>10,000 tons CO2/year for commercial aviation; >1,000

tons CO2/year for non-commercial aviation)
Lastly, under its third compliance phase, the additional sectors regulated under EU ETS were:

 Carbon capture and storage installations

 Production of petrochemicals, ammonia, nonferrous and ferrous metals,
gypsum, aluminum, as well as nitric, adipic, and glyoxylic acid
As for the price, carbon on the EU ETS is priced at USD ~$80 per ton. The EU ETS has collected
USD $80.7 billion since inception, with USD $21.8 billion in 2020 alone.

The California Global Warming Solutions Act

This ETS has been operating since 2012 and its jurisdiction covers California only.
The overall GHG emissions in this jurisdiction amount is 425 million tonnes (Mt) per year.
There are several sectors regulated under the California ETS during its first phase. They were:
(1) Large industrial facilities (cement, glass, hydrogen, iron and steel,
lead, lime manufacturing, nitric acid, petroleum and natural gas systems,
petroleum refining, and pulp and paper manufacturing)
 (2) Electricity generation
 (3) Electricity imports
 (4) Other stationary combustion
 (5) CO2 suppliers
While the following sectors were added during its second phase:
 Suppliers of natural gas
 Suppliers of certain distillate fuel oils
 Suppliers of liquid petroleum gas
 Suppliers of liquefied natural gas
There are 330 registered entities participating in the California ETS, which equates to more than
550 facilities. They commit to: (1) Return to 1990 GHG levels by 2020 (2) 40% reduction from
1990 GHG levels by 2030 (3) Achieve carbon neutrality by 2045.

The under the California ETS is USD ~$30 per ton. The California ETS has collected USD $14.24
billion since inception, including USD $1.7 billion in 2020 alone.

China’s Carbon Compliance Markets

Contrary to popular western narratives, the Chinese are serious about growing their climate-
related ambitions. The China National ETS began its operation in 2021. Its jurisdiction covers all
of China. This national ETS expanded on successful pilots in eight major regions between 2013
and 2016. It operates on the Shanghai Environment and Energy Exchange (SEEE). The overall
GHG emissions in this jurisdiction amount to 12,301 mega-tons (Mt) per year.

This dwarfs the EU ETS, which has been operating for nearly 20 years. The only sector regulated
in the China ETS is the power sector. However, the sector scope is expected to expand to cover
seven additional sectors. These are petrochemical, chemical, building materials, steel,
nonferrous metals, paper, and domestic aviation. There are 2225 registered entities that
participate in the China ETS, with a commitment to: (1) Reduce carbon emissions per unit of
GDP by 18% compared to 2020 levels by 2025 (2) Reach peak CO2 emissions and lower CO2
emissions per unit of GDP by over 65% compared to 2005 by 2030 (3) Achieve carbon neutrality
by 2060

The current price for carbon on the China ETS is USD ~$9 per ton. Other compliance credit
markets (ETS) that exist today are the Korean ETS, the Kazakhstan ETS, the New Zealand ETS,
the Japan ETS, the Canada ETS, and the Mexico ETS.

These ETS were not covered because they are not liquid, and are very
difficult for a typical investor to gain exposure to.

Voluntary Carbon Market overview

As of 2022, the real voluntary carbon market is valued at around $2 billion.
The voluntary carbon market (VCM) takes a different approach, employing a carbon offsetting
mechanism. This expands the VCM beyond national jurisdictions, opening the door for a
booming trade in carbon offsets from various sources.
In particular, renewable energy, clean technology, carbon capture, and nature-based carbon
sequestration are just some of the methods for creating carbon offsets. There’s no internal
carbon price in the VCM; instead, trade creates a market price that varies from location to
location and sector to sector. To put this in perspective, to capture one ton of CO2 emissions
you would have to grow approximately 50 trees for one-year.
While there are a wide variety of projects to choose from, they all have one thing in common.
To be part of the VCM, each project must be “additional.” This means that the removal or
reduction of carbon or GHGs would not have occurred without the offset project.
Examples of the types of projects that are investable in the VCM include:

 Renewable energy
 Industrial gas capture
 Energy efficiency
 Forestry initiatives (avoiding deforestation)
 Clean water
 Regenerative agriculture
 Wind power
 Biogas
 Oil recycling
 Solar power
 Water filters

Who participates in the VCM?

 Project developers. Project developers work to produce the carbon credits that other
sectors or industries will buy.
Consumers. This group includes private companies, NGOs, governments, universities,
and individuals that purchase carbon credits from producers.
Retail traders. Traders purchase credits in bulk from suppliers, bundle the credits in
portfolios, and then sell them to the end buyer, usually for a commission.
Brokers. A broker will buy carbon credits from a trader and market them to a consumer.
A broker will typically charge a commission. It is common for a broker to also act as a
trader.
Third-party verifiers. These are organizations, typically NGOs, that verify that a project
meets its stated objectives and volume of emissions.
Several other variables also contribute to how a carbon credit is priced, including:
Size of project. Larger projects that produce higher volumes of carbon credits often
have a lower price. Smaller projects are often more expensive to implement but
produce fewer carbon credits.
Location of offset. Where does the environmental project take place? Locations where
there is conflict and higher risk may make the project more expensive.
Vintage. What year did the emission reduction occur? Older projects are typically priced
lower.
Quality. The standard in which the project was certified can affect the price.
Co-benefits. A co-benefit is any positive impact that is produced by the project above
and beyond GHG emissions. For instance, if a project creates jobs for local communities
or increases biodiversity, these are types of co-benefits.

What is the Difference Between the Voluntary Carbon Market and the
Compliance Market?
The compliance market is regulated by national, regional, or international carbon reduction
regimes. These markets operate under a cap-and-trade system where only a certain amount of
‘allowances’ (basically a permit that ‘allows’ you to emit GHGs) are created. This then limits the
amount of GHGs that a country or industry can emit. The cap represents a finite supply of
allowances. You can’t create or remove allowance but they can be traded.
Examples of compliance carbon markets include the Kyoto Protocol, The European Union
emissions trading system, the California emissions trading system, the Australia emissions
trading system, the British Columbia emissions trading system, and the New Zealand emissions
trading system.
The voluntary carbon market functions outside of the compliance market. Those that
participate in this market don’t need to reduce their emissions, it’s entirely voluntary. Many
companies participate because they feel it is the socially responsible thing to do, because of
shareholder pressure, or because it’s a good PR move. Instead of a cap-and-trade system, the
VCM uses a project-based system in which there is no finite supply of allowances.

Voluntary vs Compliance Market

Voluntary Market Compliance Market

Exchanged Carbon offsets. Facilitated by the Allowances. Facilitated by the cap-

Commodity project-based system and-trade system.

National, regional or international

How is the
Functions outside of the compliance carbon reduction regimes E.g.
market
market. Kyoto Protocol, California Carbon
regulated?
Market

Voluntary credits tend to be cheaper

because they cannot be used in
Compliance credits tend to be
What is the compliance markets.2 Several factors
more expensive because they are
price? impact the price such as project type,
driven by regulatory obligations.3
project size, location, co-benefits, and
vintage.

Companies and governments have

Who can
Businesses, governments, NGOs, and adopted emission limits
purchase
individuals established by the United Nations
credits?
Convention on Climate change

Currently no centralized voluntary Companies that surpass their

carbon credit market. Project emission targets can sell their
Where do developers can sell credits directly to surplus credits to those looking to
credits trade? buyers, through a broker or an offset emissions. Credits can be
exchange, or sell to a retailer who then sold under the Kyoto Protocols
resells to a buyer. emissions trading scheme.4

Who verifies the Variable Carbon Market Credits?

When purchasing carbon offset credits, consumers should only consider offsets that are third-
party verified.
There are a number of standards that use different methodologies for measuring and verifying
carbon emission reduction. These standards provide a robust verification process to ensure the
credibility of emission reduction projects. The most widely used standard include:

 Verra (The Verified Carbon Standard)

 Plan Vivo
 The Gold Standard
  The American Carbon Registry
 Climate Action Reserve
 The Verified Carbon Standard Program
TOP 4 Carbon exchange
You can buy carbon offsets individually, selecting the offsets and the price you pay for them.
Sites like Nori and GoldStandard leave much of the verification process to the consumer. It’s
up to you to examine the projects and select the ones you think will provide the greatest
impact.
Other offset markets provide offsets in a portfolio. By bundling offsets from different
projects together, companies like Native can sell a wide range of offsets in one package. It’s
a bit of verification through diversification – not every project will be as successful as others
in actually reducing CO2 emissions.

Carbon pricing comparison and forecast

According to a 2020 report by the World Bank, carbon prices on the VCM start at less than
US$1/ton CO2e and increase to US$119/ton CO2e. And the price for almost half of emissions
are at less than US$10/tCO2e.
Pricing can also be affected by the co-benefits generated by the project. Projects that meet the
UN’s SDGs can help to increase the value of the carbon credits.
To meet the temperature goals outlined in the Paris Agreement, the High-Level Commission on
Carbon Prices stated that prices of at least US$40-80/tCO2 were necessary by 2020 and US$50
to $100/tCO2e by 2030. The OECD estimates a price of US$147 is needed by 2030 to reach net-
zero emissions by 2050.
In the compliance market, the current weighted carbon price is $34.99 This is higher than the
VCM pricing but still below the High-Level Commission threshold.
The bottom line when looking at both the VCM and compliance markets is that the current
carbon prices are too low to meet targets.
There is currently no centralized voluntary carbon market. Instead, project developers, or
companies can sell their credits directly to buyers or through a broker. Project developers can
also sell their credits to a retailer who can then resell the credits to a buyer. All voluntary
credits must be verified by an independent third party and must adhere to existing standards.
Voluntary Demand Scenarios
There is incredible demand projected for the voluntary market. According to the Taskforce on
Scaling Voluntary Markets, the market will grow to around 15-fold from 0.1 to 1.5-2 GtCO2 of
carbon credits per year in 2030. And that will scale up to a maximum of 100-fold by 2050 (7-13
GtCO2 of carbon credits per year).
PROJECT LUNCH METHODOLOGY

Each new carbon offset has five major points in its lifecycle:

 Development of a new offset type

 Selection of an offset methodology
 Planning of an individual project using that methodology
 Implementation and verification of the project, registration with a carbon authority,
and the beginning of offset issuance
 Transfer to the purchaser and retirement of the offsets

Each phase represents an opportunity for substantial investment: in new offset technologies, in
offset project ideation and development, and in offsets themselves.

Both price and risk begin extremely high, as there is no guarantee emissions will be removed.
As the project enters the planning phase, the price falls and terms improve in order to attract
investment.

Prices rise again as validation, verification, and registration take place—this means the risk of
delivery has decreased and high-quality offsets are more likely. Then prices level off or rise
slightly as the risk of double-counting or leakage rises and brokers and retailers take their cut.

Offset purchasers should become familiar with each point on this curve. It will help them
determine how to maximize the ROI and other benefits their organization receives in return for
offset purchases.
Offset Type Development

Dozens of offset types, such as methane capture from landfills and large hydro projects, have
been established over the past thirty years. The two most popular types are currently wind and
reforestation.

The problem is that while many types of carbon offsets have proven effective at removing CO2
emissions from the atmosphere, those currently in existence are only stop-gap measures.

For example, to erase the emissions from aviation, the entire United States would need to be
planted with trees. That’s why investment in new types of offsets is so vital: the technology that
will arrest global warming has likely not been invented yet.

Fortunately, new technologies and methods of removing CO2 emissions from the atmosphere
are constantly moving along the timeline above. Experimental types of offsets currently in the
funding and research phase include:

 Accelerating mineral weathering in rocks using electrochemical forces.

 Genetically engineering phytoplankton to capture CO2 in the ocean.
 Flooding deserts to create manmade oases that phytoplankton can inhabit.
 Developing enzymes that capture carbon.
The holy grail of offset development borders on alchemy: turning atmospheric CO2 into a
usable product. For example, Coca-Cola has already signed a deal with a company that uses
direct air capture of CO2 to make its soft drinks bubbly.

Purchasing carbon credits at this stage is risky:

During type development, there is no guarantee that carbon offsets will be able to be produced
from the eventuating invention.

It’s also expensive. Experimental methods of removing carbon from the atmosphere can cost
hundreds of dollars per ton during development.

For example, Climeworks—which captures CO2 and sends it to a local greenhouse (the irony!)
—says it currently costs about $600 to remove a ton of CO2 using their methods. (Their cost per
tonne is expected to drop below $100 within the decade.)

Investing in carbon offsets at this point does not net an organization any real offsets. Rather, it
involves investing directly in companies that are working on breakthrough technology for the
capture of CO2.

Thus, it should be undertaken by companies that can make use of the possible co-benefits of
the eventual offsets (think of Coca-Cola’s uses for the carbon), companies that do not need the
offsets for compliance, and companies that want a reputational bump from supporting the
development of new technology.

Offset Methodology Selection

Once a carbon offset technology is ready for a new project to be built around it, it requires the
creation or selection of an offset methodology, which is a complex set of rules around the
creation of that offset.

The methodology provides guardrails for a project developer, outlining what they must do to
establish a baseline for the project, determine additionality, calculate project emissions
reductions, and monitor external parameters to calculate absolute emission reductions.

Entire libraries of approved methodologies already exist that cover most developed project
types. It is up to project developers, though, if they want to create a brand new methodology to
get the program approved and moving forward.

That adds a resource-intensive, risky layer to the project, but it can be necessary for offset
developers that want to attempt novel project activities.

Investing at this point is an ultra-high-risk, high-reward proposition. If the buyer is heavily

involved in the selection or creation of the methodology, it can yield assurances as to the
quality of the resulting carbon offsets and their relevance to the buyer’s operations.

That is paired, however, with a long lead time before offset delivery (likely a few years) and a
high measure of risk if the methodology is not approved.

This option is for companies that have a lot of time before they need offsets, and have the time
to invest in researching new offset projects and building relationships with project developers.

Offset Project Inception: Project Planning, Validation, and Registration

Once a methodology has been chosen, the project developers generate a project plan that
assesses the feasibility of the project, its environmental impacts and possible risks to
development.

The plan is solidified into a project design document, which outlines the anticipate reduction in
emissions from the project, plans for quantifying and monitoring those benefits on an ongoing
basis, and proof of additionality for the project.

Independent third-party verifiers examine and approve the project design, ensuring the
emissions reductions will actually take place. Then—and only then—can the carbon offset
program be registered. This official registration sets the program up to begin issuing carbon
offsets.
There are two general options for investment at this stage, both of which involve investing in
the project directly:

 Investing for the right to a specific percentage of the offsets created by the project.
 Investing for the right to a specific number of offsets created by the project.
The former requires (and enables) much deeper engagement and a broader understanding of
the mechanisms of carbon offsets than do later stages.

Investors must be able to evaluate the strengths and weaknesses of specific projects alongside
third-party verifiers to decide whether the project is likely to deliver on its plans.

The latter generally looks like an Emission Reduction Purchase Agreement (ERPA). ERPAs take
risk away from project developers by letting them pre-sell a specific volume of offsets. In
exchange for taking on the delivery risk, buyers or investors get to lock in below-market offset
prices.

Both options have a lower cost than later in the development process, and buyers may be able
to invest in at-cost offsets. As always, that comes with a price: the offsets will be delivered over
time, not all at once, and this type of investment generally requires a long-term agreement (as
with an ERPA).

Offset Project Implementation: Verification and Issuance

Projects that have become operational must be monitored over a period of time based on the
original methodology and plan. Then, another verification audit process assesses the realness
and quality of the claimed reduction in CO2 emissions; these verifications typically occur a year
apart.

Once a verification has been passed, the project developer can issue carbon offsets equal to the
number of tons of CO2 that were verified to have been captured or reduced.

Those verified offsets are deposited into the project developer’s offset “bank account.” This is
where the transition from “project readiness” to “pay for performance” takes place. In other
words, those offsets are no longer just theoretical; they are continually being created, and the
developer can begin delivering on long-term contracts.

Offset Sale and Transfer

Any offsets that have not been pre-sold become available for direct, one-off purchases from
consumers and corporations. While purchasing directly from a project developer can help avoid
transaction costs, it is not without its risks—especially in terms of the quality of the offsets.

Since there is no centralized marketplace for the voluntary carbon market, finding buyers
remains challenging for project developers and identifying quality offsets is difficult for all but
the most knowledgeable buyers.
Thus, three new entities have been created to facilitate the easy purchase of offsets: brokers,
exchanges, and retailers.

Brokers have purchased credits from the project developer or an exchange and can transfer
them to clients or retire them on their behalf. Brokers can be used to create a diverse basket of
offset credits from different projects, different methodologies, and different project types.

Beware that some brokers sell offsets from projects they have directly invested in; while that
may reduce fees, it might also make the broker biased toward selling their own offsets,
regardless of quality.

Exchanges are places for developers to sell directly to buyers (and for traders to invest in
carbon offsets). North America and Europe host a few environmental commodity exchanges
that list carbon offsets and facilitate transfers.

While purchasing offsets in an exchange can be as easy as using Robinhood, it can be difficult to
ascertain the exact quality of the offsets.

Retailers sell off-the-shelf carbon credits (just like the old boxes of Microsoft Windows CDs),
then retire them on the behalf of the buyer. Retailers have physical ownership of the offset,
while brokers and exchanges do not.

Purchasing carbon credits from a retailer offers the same benefits as buying from Best Buy:
unlike Amazon, their employees can help companies understand the process of offsetting and
what types of offsets are most likely to help meet their goals.

Offset Retirement

Offsets can be sold and resold. With each new transaction, they are transferred into a different
account in the offset program’s registry. Those new buyers can hold them, transfer them to
another account through a sale, or retire them.

Offsets are retired by “using” them by claiming their verified CO2 reductions against an
emissions reduction target. Each carbon offset registry has a retirement process that prevents
the offset from being transferred or used again—think of it like a dollar bill being removed from
circulation.

Making Your Offset Investment Decision

The opportunities to purchase throughout the carbon credit lifecycle look like this:

Where you choose to invest in the carbon offset lifecycle depends on myriad factors, including:

 The business goals and expected advantages behind your purchase.

  How quickly you anticipate needing the offsets to be delivered.
 The guaranteed quantity of offsets you will need.
 The price level that can be afforded or that makes the most financial sense.
 The amount of time and effort available to apply to the offset acquisition.
Answers to each of these questions will guide you toward options that differ in their timing,
volume, and price, and your ability to evaluate (or influence) their quality.