How Does a Carbon Credit Exchange Determine Credit Prices?

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The carbon market is a global network of businesses, institutions and individuals that buy and sell emissions reduction credits to offset part or all of their own greenhouse gas (GHG) footprint. There are two significant markets within the carbon market, a regulated market set by "cap-and-trade" regulations at state and regional levels and a voluntary market where businesses and individuals can purchase credits on their own accord.

The regulatory market is set by carbon "cap-and-trade" programs that are designed to reduce GHG emissions through a market-oriented approach. In this model, a regulator sets an annual limit for companies to emit, or "cap", which then decreases over time. If a company emits more than the cap, they need to purchase credits from another business to keep from paying heavy fines. These credits are then traded in a carbon market, allowing the purchasing and selling of the "permission slips" to avoid fines and meet emissions targets.

carbon credit exchange prices depend on a variety of factors, including the type of project that produces a particular credit (for example renewable energy, clean cookstove or forestry), the vintage - that's the year it was issued - and the country of origin or "host" in which the carbon project is located. A credit's price may also increase if the underlying project generates additional 'co-benefits' and helps to meet some of the United Nations Sustainable Development Goals (SDGs).

In addition to buying and selling carbon credits, this market includes brokers that link supply and demand. In the carbon market, there is often an overlap of roles, with traders, financiers and project developers assuming multiple responsibilities. For example, many brokerage firms have trading and project finance arms, while financial institutions will often invest in both a brokering firm and projects that produce carbon credits to help meet their lending commitments.

As with other commodities, carbon credits can be bought and sold in the form of portfolios containing hundreds to thousands of equivalent tons of CO2. The end buyers for these are primarily large corporations, but there is also growing interest from individual consumers who want to demonstrate their own environmental responsibility.

In the regulated market, carbon credits are mainly purchased by businesses that are required to purchase them under a state or regional cap-and-trade program. However, more and more corporations are looking at setting their own net-zero goals and this is driving new interest in the voluntary market as well.