Are Carbon Credits Real Assets

Carbon has gained a lot of traction and popularity over the past 10 years, but especially over the past 2.

Most people are still confused about the differences between carbon assets like allowances, offsets, removals. There are many good writings on that.

Here is how I see them:

There are two types of carbon markets:

  1. Compliance market, which uses allowances. Companies pay to pollute with a higher price costing them more and driving investments to reduce emissions. EU ETS is the largest market.
  2. Voluntary market
  • Offsets: project that prevents emissions, ie build solar plant instead of coal plant. CO2 neither increase, nor decrease. Most issued credits to date.
  • Removals: actively reduce CO2 via carbon capture, i.e. planting trees.

Klima DAO currently uses BCT, which is a pool of voluntary credits.

Carbon credits as commodities

Since carbon became more widely traded on the markets, it has been labelled a commodity. I want to talk a bit about the nature of the different carbon assets as I think people need to have a good understanding.

Compliance credits.

The cap-and-trade schemes is where carbon allowances are traded. Let’s take the European Union Emissions Trading Scheme (EU ETS), the largest global market with a value of over EUR 200bn.

The asset in this market is called a European Union Allowance (EUA) and is measured in tons of CO2e (CO2 equivalent). It is fully fungible, meaning all units on the market are the same and 100% interchangeable.

1 EUA grants its holder the permission to emit 1 ton CO2e. The holders are industrial, transportation and energy companies above a certain size.

The EU ETS as a market started back in 2005. When I say market, here is what that means.

This market did not emerge naturally because there was a need for it. It was created top down by the European Commission. Not a single market participant wanted or needed it, because it basically added an artificial cost to their operations.

The same way all the EU members came together and decided to create the market, they can decide to shut it down (not saying it is easy, but it is theoretically possible). There will be no more EUAs as there is no natural use for them.

EUAs are simply tradable penalty units, which come from the EU and go back to the EU after they’ve been used. They measure the amount of penalty to be paid based on the market price. EUAs have no real use other than being a policy instrument. This is a major difference to real commodities like oil, silver or wheat.

The only thing EUAs have in common with regular commodities is that their price is driven by supply, demand and external speculation.

Voluntary vs compliance credits.

You may see abbreviations like VER (Voluntary Emission Reduction) or VCU (Verified Carbon Unit), but they denote the same thing.

The only major thing EUAs and VERs have in common is they both represent the same unit of account — 1 ton CO2e. That’s pretty much where the similarities stop.

  • VERs are, well, voluntary as opposed to the mandatory EUAs.
  • VERs are project based while EUAs are scheme-wide instruments.
  • VERs offset or remove carbon, EUAs penalize polluters.
  • VERs are not fungible across projects and issuance years (vintages). Only fungible within the respective batch issued within the same vintage. EUAs are fully fungible within the current scheme phase.
  • VERs are issued only after a project has been running and saving emissions (after investments have been done). EUAs force investments upfront.
  • VERs are issued according to a specific carbon standard (rules) like Verra or Gold Standard. EUAs are centralized.
  • VERs need to be verified by an independent third party. EUAs work similarly, whereas a validator checks the actual emissions every year and issues a report.

Back to the question: are voluntary carbon credits commodities?

Let’s see.

They are standardized units that represent a confirmation that a green project like a solar power plant has been developed instead of a (less/non)-green coal power plant for example.

Note: there is a requirement for carbon projects called additionality, so I’m simplifying and won’t into details, but let’s assume a project is additional.

The solar plant prevents the emission of new CO2, i.e. it offsets these new emissions. However, it doesn’t remove any from the atmosphere. These representations of offsets are the carbon credits and they have a market price.

Are they commodities?

I’d argue Yes.

Yes, because anyone (person/company) who buys and offsets their emissions basically “claims” these savings. It doesn’t mean the person has not polluted, it means the carbon project exported the savings to her/him. Basically you pollute here, the project does not pollute over there. This is better than allowances. The best of all are removals, which actively reduce global emissions, instead of preventing new ones.

Right now, our only scalable removal option are trees, but we desperately need carbon capture tech at scale, otherwise we won’t get global emissions down fast enough.

Do VERs have a real utility?

Here is a thought experiment: the bread you bought and ate enabled the wheat farmer to do what he does. Is the biological need to eat similar to the need to be carbon neutral? This becomes a bit philosophical, but if we assume that without going neutral (or even positive) climate change becomes a real risk to our biology, then you could infer a similar utility.

Utility value chain

People put a lot of importance on retiring (burning) VERs as the proof to be offset. This is correct because only the end buyer can claim the savings. VERs often change hands multiple times before being retired, which, while being inefficient and costly (price increases), helps the VERs to reach the most willing end buyer.

People also argue that until the VERs are retired, the benefits somehow don’t take place. This is especially important in the context of Klima DAO which hoards VERs instead of burning, but have offered a possible explanation here.

While the ultimate offsetting benefits can only be claimed by burning, don’t forget that it is the first buyer who is the most important and who enables the liquidity event for the project developer and ultimately, the continuation of the project and emission savings. What happens between the first and last buyer is important, but comes secondary in my opinion.

Conclusion

I would argue that voluntary credits offer better / best overall potential to finance the fight against global warming and could be perceived as an asset / commodity.

I would also argue that funding the projects via the initial carbon buyers is the primary goal and offsetting comes secondary as it merely reflects the “accounting” side and ensures that the benefits can only be claimed once. Ultimately, though, even if we assume that nobody ever claims the benefits, calculating the global emissions and ensuring funding for their offsetting and especially removal is what we should focus on.

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