Offsets vs Credits: Workable Solution or Woke Carbon Wheeze?

Carbon
offsets
often
get
conflated
with
another
instrument
that
shares
a
similar
name:

carbon
credits.
Both
are
the
subject
of
increasing
interest
from
investment
firms.

For
example,
Pimco
features
a
small
allocation
to
carbon
credits
in
its
Pimco
Commodity
Real
Return PCRIX,
and
KraneShares
offers
KraneShares
Global
Carbon
Offset
ETF KSET.
Both
funds
argue
investments
in
carbon
may
allow
ordinary
investors
to
benefit
financially
from
decarbonisation
efforts.

Even
so,
carbon
credits
and
carbon
offsets
are
fundamentally
different,
with
implications
for
investors
seeking
to
understand
how
these
instruments
work
in
practice.

It
starts
with
the
philosophical
problems
that
each
security
is
trying
to
tackle.
Carbon
offsets
are
designed
to
help
consumers
counteract
the
impact
of
expected
or
past
emissions.

Carbon
credits,
meanwhile,
make
it
more
expensive
for
companies
in
regulated
industries
to
pollute
by
charging
them
per
unit
of
carbon
they
emit,
which
has
the
effect
of
disincentivizing
future
emissions.

Key
Differences
Between
Carbon
Credits
and
Carbon
Offsets

Another
way
to
think
about
it
is
that
carbon
offsets
are
not
unlike
the indulgences
of
medieval
Christianity,
in
the
sense
that
people
buy
them
in
order
to
atone
for
their
environmental
sins.
Meanwhile,
carbon
credits
are
more
like
a
toll
on
an
expressway:
A
government
may
actually
require
companies
to
pay
in
order
to
emit,
and
carbon
credits
are
the
fare
they
pay
for
the
right
to
do
so.

How
Does
Carbon
Pricing
Work?

Fundamentally,
carbon
offsets
and
carbon
credits
answer
two
different
questions.
Offsets
serve
as
a
proxy
for
how
much
people
are willing to
pay
to
defray
the
environmental
cost
of
their
activities.
Meanwhile,
carbon
credits
address
the
question
of
how
much
businesses
are able to
pay
to
keep
operating.

Carbon
offsets
measure
people’s
(and
companies’)
willingness
to
pay
for
their
own
personal
carbon
footprint
by
pricing
the
cost
of
offsetting
activities.
These
offsetting
activities
fall
into
two
categories:
avoidance,
which
can
happen
through
things
like
stripping
methane
from
a
landfill,
or
removal,
which
generally
happens
through
planting
trees.
Because
offsetting
activities
differ
depending
on
the
program,
carbon
offsets
themselves
are
heterogeneous,
and
prices
tend
to
vary
based
on
the
activity
they
finance
and
the
quality
of
the
program.

Meanwhile,
carbon
credits
track
companies’
ability
to
pay
for
their
operations
if
their
emissions
exceed
preset
limits.
Because
participation
is
required
by
law
in
most
cases,
the
market
for
carbon
credits
is
much
bigger
than
the
market
for
carbon
offsets.
This
holds
true
in
spite
of
the
fact
that
offsets
are
more
well-known.

Why
is
this?
Certain
businesses
have
to
purchase
carbon
credits,
whereas
in
most
cases
the
choice
to
purchase
an
offset
is
purely
voluntary.
Consequently,
according
to
the
World
Bank,
carbon
credits
regulate
around
18%
of
the
world’s
emissions,
while
carbon
offsets
track
far
less
than
1%.

Carbon
Credits
Market
Dwarfs
Carbon
Offsets

Participation
in
the
carbon
credit
markets
is
enforced
through
a
special
type
of
program
called
a
“cap-and-trade”
programme.
The
cap-and-trade
programme
mandates
that
businesses
in
specified
sectors
keep
carbon
emissions
under
a
particular
ceiling,
called
a
“cap.”
Firms
that
pollute
less
than
their
limit
can
“trade”
their
excess
carbon
on
the
open
market.
A
carbon
credit
is
the
security
that
is
created
when
a
company
opts
to
trade
its
extra
carbon.
The
European
Union
has
the
oldest
and
largest
market,
but
other
places
like
California
and
China
have
them,
too.

More
Importantly, Does Carbon
Pricing
Work?

Despite
the
depth
and
sophistication
of
these
markets,
there
is
still
a
lot
of
daylight
between
what
carbon
pricing
programs
aim
to
do
and
what
they
can
feasibly
accomplish.

While
awareness
of
carbon
offsets
has
increased
in
recent
years,
participation
in
carbon
offsetting
remains muted.
The
biggest
audience
for
carbon
offsets
today
is
consumers,
and
for
consumers
other
considerations
like
price
and
convenience
tend
to
outweigh
the
environmental
impact
of
the
purchase
they’re
about
to
make.

The
chief
issue
plaguing
cap-and-trade
programs
is
that
governments
set
the
annual
emissions
caps
a
few
years
in
advance.
In
doing
so,
regulators
project
how
much
they
expect
certain
sectors
will
pollute
in
a
given
year.
Our
research
finds
most
of
these
covered
sectors
are
reducing
emissions
faster
than
government
forecasts,
which
is
a
good
thing.
But
when
companies
beat
expectations,
it
leads
to
a
glut
of
credits
on
the
market,
and
that
means
carbon
is
cheap
to
trade.

In
fact,
carbon-linked
securities
don’t
charge
enough
of
an
economic
penalty
to
directly
assist
in
meeting
climate
agreements.
Economists
suggest
that
the
price
of
carbon
needed
to
meet
the Paris
Agreement is
somewhere
above
$50
per
tonne.
As
of
2023,
no
carbon
offsets
command
a
premium
that
high,
and
just
four
carbon
credits
across
the
36
markets
that
we
cover
cost
more
than
that.

Carbon
Credits
Charge
More
Per
Tonne
of
Carbon

What
Are
the
Takeaways
For
Investors?

Although
they
are
very
different,
what
carbon
credits
and
offsets
do
have
in
common
is
neither
carbon
offsets
nor
carbon
credits
charge
a
price
that
could
be
considered
punitive,
and
there’s
no
guarantee
that
they
ever
will.
Proponents
of
an
allocation
to
carbon-linked
securities
argue
that
carbon
securities
are
a
“sure
thing”
because,
conceptually,
the
price
of
carbon has to
rise
in
order
to
meet
climate
agreements. 

But
this
conclusion
rests
on
the
assumption
that
the
price
of
carbon can rise.

For
carbon
offsets,
that
assumption
can
only
hold
true
if
people
(and
companies)
have
the
appetite
and
resources
to
follow
through
on
their
self-imposed
commitments.
For
carbon
credits,
a
similar
principle
applies,
but
it’s
a
question
of
political
willpower:
for
these
programmes
to
produce
consistent
price
signals,
governments
need
to
set
the
right
standard
and
stick
to
it
even
when
it’s
unpopular.

Our
research
finds
that,
in
most
cases,
regulators
are
a
little
better
at
it
than
individuals
and
companies,
but
not
much.
The
sectors
regulated
under
cap-and-trade
programs
have
generally
cut
emissions
faster
than
government
forecasts,
resulting
in
cheap
carbon.

Carbon
offsets
and
carbon
credits
obey
fundamentally
different
principles.
Importantly,
carbon
credits
are
creatures
of
regulation,
and
regulators
can
create
a
market
and
scale
it
much
faster
than
individuals
can.
However,
it
also
means
that
the
price
of
carbon
credits
depends
on
the
effectiveness
of
regulators
at
following
through
on
their
aims
once
those
markets
go
live.
Ultimately,
though,
investors’
success
in
either
security
depends
on
the
outcomes
of
carbon
markets
rather
than
the
intrinsic
value
of
carbon
itself.

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