Carbon credits are a part of “cap-and-trade” policies. The cap represents the amount of carbon emissions a company may be limited to producing. The cap generally decreases over time. The trade represents a company’s ability to buy and sell carbon credits to increase or decrease its allowed carbon emissions. These programs aren’t as common in the U.S. as they are elsewhere, but several states have joined regional initiatives to enact such policies. Carbon credits present a way for companies to profit by reducing their carbon emissions. However, it’s not just companies that can make money from them. There are also opportunities for investors to profit from carbon credits. Learn more about how and why to invest in carbon credits.
How To Invest in Carbon Credits
In the U.S., programs to reduce carbon emissions are largely voluntary and don’t exist in most states. As a result, there aren’t that many ways to invest in carbon credits (although there likely will be more in the future). That said, here are a few ways investors can get started.
Carbon-Credit ETFs
An exchange-traded fund (ETF) is a pooled investment that tracks the performance of underlying assets. A carbon-credit ETF tracks the performance of the carbon market. For example, the KraneShares Global Carbon Strategy ETF (KRBN) is benchmarked to the IHS Markit Global Carbon Index, which tracks carbon-credit futures contracts (we’ll cover carbon-credit futures more in-depth shortly). The fund was created in 2020 and as of Dec. 31, 2021, had experienced a leap in net asset value (NAV) of over 154% since its inception. Other similar products include the KraneShares European Carbon Allowance Strategy ETF (KEUA) and the KraneShares California Carbon Allowance Strategy ETF (KCCA).
Carbon-Credit Futures
Another way to invest in carbon credits is through carbon-credit futures. A futures contract is a type of derivative in which two parties agree to trade an underlying asset at a specific date for a specific price. In the case of these futures, the carbon credits are the underlying assets.
Individual Companies
A final way for individual investors to indirectly invest in carbon credits is by investing in companies that trade them. For example, Microsoft has announced its goal of becoming “carbon negative” by 2030, and as a part of that effort, contracted 1.3 million carbon offset credits for 2021. Shell is another example of a company involved in the carbon credit industry. But rather than buying carbon credits, Shell sells and trades in credits with other companies, then uses the proceeds to fund its global portfolio of environmental products.
What You Need To Know Before You Invest in Carbon Credits
As with any investment, it’s important to understand what you’re getting into when you put money into carbon credits. Because these investments are relatively new, there’s limited information available, as well as limited options for investing. The good news is that because you can invest in carbon credits through ETFs, it’s an accessible investment anyone can add to a portfolio. That said, there are risks to investing in carbon credits in any form, and it’s important to understand them.
Understand the Risks of Investing in Carbon Credits
While it’s certainly possible to make money investing in carbon credits, there are also some critical risks to be aware of. First, unlike some ETFs, carbon-credit ETFs won’t give you broad market exposure. For example, the KraneShares Global Carbon Strategy ETF only gives you exposure to companies in Europe, California, and parts of the eastern U.S. As a result, a well-diversified portfolio would require putting most of your money in investments other than carbon-credit ETFs, futures, or related individual companies. It’s also worth noting that while ETFs aren’t inherently a high-risk investment, carbon-credit ETFs often track benchmarks that follow the performance of carbon-credit futures. Futures contracts are a type of derivative, which are considered volatile and speculative.
Pros and Cons of Investing in Carbon Credits
Pros Explained
Potential financial return: As with any investment, a key benefit of investing in carbon credits is the ability to earn a financial return. As mentioned, the value of the KraneShares Global Carbon Strategy ETF has more than doubled since it started in mid-2020, delivering a return in terms of NAV of more than 154% as of Dec. 31, 2021.Benefits the environment: Carbon credits are designed to limit companies to a certain amount of carbon emissions each year. Environmentally conscious investors might turn to carbon credits as a way to invest in alignment with their values.Accessible investment choices: Investing in carbon credits doesn’t have to be complicated. Thanks to carbon-credit ETFs, investors can access exposure to carbon offsets without picking and choosing individual companies or getting involved in trading carbon futures.
Cons Explained
Possibly high-risk: As with any investment, there are risks to investing in carbon credits. Carbon-credit ETFs track the performance of carbon futures. Futures can be volatile and are generally considered an advanced investment strategy. Additionally, because carbon-credit investments are relatively new, there’s limited performance history to assess.Limited diversification: Many people enjoy ETFs because they can provide diversification to a portfolio. However, in the case of carbon-credit ETFs, diversification is limited. Allowing carbon credits to make up too large a share of your portfolio can also increase your risk.Debate about actual environmental impact: While carbon credits are designed to limit a company’s overall carbon emissions, the environmental impact could be debated. First, these programs aren’t widespread in the U.S. Cap-and-trade programs only exist in the eastern part of the U.S. and in California. Furthermore, companies can buy additional carbon credits instead of reducing their carbon emissions, which, although it serves as a financial penalty, doesn’t have a positive environmental impact.
How To Start Investing in Carbon Credits
Individuals can’t invest directly in carbon credits. Instead, carbon-credit ETFs are the simplest and most accessible way for retail investors to get started.
Open an Account
To trade ETFs and other securities, you’ll first need to open a brokerage account. You can either trade carbon ETFs from an existing account, or open a new one if you don’t already have one. Even popular investment apps can be used to trade these ETFs, as long as the platform in question allows for ETF trading.
Decide Which Carbon-Credit ETF To Buy
Once you’ve opened your brokerage account, it’s time to decide which ETF to purchase. Because these ETFs are just getting started, there are few options from which to choose. Funds are currently available for global, European, and California carbon futures.
Make Your First Transaction
Once you’ve decided which carbon-credit ETF to buy, you can make your purchase. To get started, log in to your brokerage account and search for the ticker symbol of the ETF you want to buy. ETFs trade like stocks on stock exchanges throughout the trading day. Just like stocks, ETFs trade as shares, and you can get started for as little as the price of a single share.
What To Watch Out for After You Invest in Carbon Credits
Once you’ve made your carbon-credit ETF share purchase, wait and see how it performs. Over time, many carbon-credit ETFs have increased in price. However, they still experience volatility, and your portfolio’s value may ebb and flow over time. While you shouldn’t take an entirely set-it-and-forget-it approach, it’s also important to be patient and to avoid emotional decisions. It’s also helpful to understand what happens when you sell your investment. If you sell your investment for more than you purchased it, you could be on the hook for capital gains taxes. How much you’ll pay depends on whether you held the investment for more or less than one year. On the other hand, selling your investment for less than you bought it could result in a capital loss, which could reduce your tax liability.
Should You Invest in Carbon Credits?
Investing in carbon credits can allow you to make money while supporting an environmental cause. But are carbon credits the right investment for you? There’s a lot to consider when it comes to investing in carbon credits. While carbon-credit ETFs are the most accessible way to benefit from them, they do come with volatility, limited diversification, and questions about how much of an environmental impact they have. It’s true that since their inception, carbon-credit ETFs have had positive returns, but past performance is no guarantee of future results. Because futures contracts are known to be volatile and speculative in nature, you’re likely to experience price fluctuations. As you decide whether carbon-credit ETFs are right for you, look at the rest of your portfolio and consider how these investments would fit into it, ensuring your portfolio remains diversified. The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.
