How Carbon Credits Work - The Basic Structure of Emissions Trading
Carbon credits are certificates that quantify greenhouse gas emission reductions or removals in a tradable form. Under cap-and-trade emissions trading systems, governments allocate emission allowances to companies. Companies that emit less than their allowance can sell the surplus on the market, while those exceeding their allowance must purchase the shortfall. In the EU Emissions Trading System (EU-ETS), the world's largest emissions trading market, carbon prices ranged from 80 to 100 euros per ton in 2023. In the voluntary carbon market, companies purchase credits generated from forest conservation or renewable energy projects to offset their own emissions.
In Japan, a carbon credit market was launched on the Tokyo Stock Exchange in October 2023, enabling trading of J-Credits. Trading prices range from several thousand to tens of thousands of yen per ton - significantly lower than EU-ETS levels - but prices are expected to rise as the system expands.
Carbon Price Drivers - The Dynamics of Policy, Technology, and Supply-Demand
Carbon credit prices fluctuate based on multiple factors including the stringency of regulations, the supply of emission allowances, economic activity levels, and advances in renewable energy technology. The EU has set a target to reduce greenhouse gas emissions by 55% from 1990 levels by 2030, and the gradual reduction of emission allowances creates upward pressure on carbon prices. Conversely, during economic downturns, emissions decrease along with reduced industrial activity, causing carbon prices to decline.Books on carbon pricing and climate policy (Amazon) provide detailed analysis of price movement mechanisms.
Over the long term, regulatory tightening across countries to meet Paris Agreement targets is expected to support an upward trend in carbon prices. The International Energy Agency's (IEA) net-zero scenario projects carbon prices reaching $130 per ton in developed countries by 2030 and $250 per ton by 2050. This long-term price appreciation trend is the primary factor drawing attention to carbon credits as an investment asset.
How Individual Investors Can Access the Carbon Market - Using ETFs and Futures
Individual investors can participate in the carbon market through ETFs and futures contracts linked to carbon credits. The KraneShares Global Carbon Strategy ETF (KRBN) invests in emission allowance futures from the EU-ETS, California, and RGGI (Regional Greenhouse Gas Initiative in the northeastern US), offering a vehicle to ride the carbon price uptrend. However, the carbon market carries the risk of sharp price swings from policy changes - a single shift in regulatory direction can dramatically alter market conditions. Limiting your allocation to 3% to 5% of your total portfolio and positioning it as a diversified bet on the long-term decarbonization trend is a prudent approach.
The carbon market is a growth sector expected to expand alongside progress in climate change mitigation.Books on decarbonization business and environmental investing (Amazon) are also helpful for understanding market trends.
Next Actions for Getting Started with Carbon Credit Investing
If you are considering carbon market investments, start by understanding the differences between the EU-ETS and J-Credit systems and the characteristics of each market. Accessing carbon ETFs like KRBN through an international brokerage account is the most straightforward method. Domestically, monitor developments in the Tokyo Stock Exchange's carbon credit market and review the participation requirements for J-Credit trading.
Given the high policy risk in carbon markets, limit your investment to 3% to 5% of your total portfolio and adopt a long-term holding strategy. Regularly following climate change policy developments in major countries, COP (Conference of the Parties) agreements, and progress toward national emission reduction targets will provide the information needed to assess the direction of carbon prices.