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Carbon Credits

2 minute read

For those who want to save the planet, the market can help via carbon credits. Profits from these are like a breath of fresh air.

Carbon credit trading was first championed by the economist Ronald Coase in the 1960s. He believed that economists should focus their analyses on real markets. One of his most famous contributions is the Coase theorem, which states that if people can trade externalities, it leads to the most efficient outcomes. Partly due to this work, Coase won a Nobel Prize in Economics in 1991.

Externalities are benefits to one economic party that download costs onto another party who did not agree to this arrangement. This is important because pollution is the most commonly seen externality.

This idea is the backbone of the Kyoto Protocol and more recently the Paris Agreement of 2015. The idea is that if an amount of acceptable pollution per year is determined and then industry is allowed to trade these emissions, then the market will not over-pollute. Not only that, but industry will price pollution efficiently as well.

There have been some struggles getting all countries to remain committed, with Europe showing the most resolve so far.

The emissions are traded on the ICE, the Intercontinental Commodity Exchange. They come in different forms based on the climate agreement they connect with. There are Certified Emissions Reduction (CER) credits for the Kyoto Protocol and EU Allowances (EUA) for the European Union Emissions Trading Scheme.

Each unit of these futures represents a metric tonne of CO2 or equivalent gas emissions. Currently, futures contracts for them represent 1000 such units/tonnes. The going rate for EUA contracts is around 5 euros, and for CER only around 0.2. This highlights the difference in how seriously the European Scheme (with EUA contracts) is taken vs the Kyoto Protocol (with CER contracts).

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