How is the Price of Carbon Determined?

The price of carbon can vary widely. Compliance carbon trading systems have pricing based on local economies and systems, but even voluntary market prices can have a huge variance depending on many factors. This article will illuminate some of the factors that affect the price of carbon and help you to understand the pricing of the projects you support.

Carbon Pricing

Carbon pricing is a valuable approach to lessening global carbon emissions by designating a set monetary value for a single ton of carbon released into the atmosphere. With this price, individuals and companies who produce emissions are expected to take financial responsibility for their own emissions.

This financial consequence for pollution both offers funding for projects that remove carbon from the atmosphere and provides an incentive to reduce overall carbon emissions. Putting a price on carbon is widely viewed as one of the best ways to improve the global situation as it encourages the greatest amount of improvement with minimal expense.

There are two types of carbon markets, compliance and voluntary, each of which have unique factors that affect the price assigned to a ton of carbon.

Compliance Markets

Much of carbon pricing is undertaken by governments or other public authorities as a means to reduce large-scale carbon footprints through policy initiatives. There are two main approaches to mandatory carbon markets:

Emissions Trading Systems

In an emissions trading system (ETS), or cap-and-trade system, there is a cap on the number of carbon emissions that will be produced by the entire system.

Each company in the system is allocated a certain number of credits to start with and then companies can trade credits between themselves if they need more or less. This way the total emissions of carbon are planned for and maintained.

In ETS systems, carbon credits can be bought, sold, and traded just like stocks. While there is some government control exerted over carbon prices in this type of system, price changes can also be strongly influenced by the market itself and changes in supply and demand.

As we move closer to Paris Agreement deadlines for lowering global emissions, governments have been further limiting the number of carbon credits available and demand has increased. This has led to increasing prices over time, particularly in the past year.

Carbon Tax

In a carbon tax system, a government places a set tax amount on each ton of carbon produced, which can apply either to the entire economy or to specific sectors. In this system, everyone pays for their emissions according to the tax rate and can lower the amount paid by reducing their total emissions.

Unlike an ETF, the price of carbon is controlled and not subject to marketplace changes; In order to reduce overall emissions, however, prices will gradually increase over time.
Hybrid Approaches
There are also various mixed systems that incorporate elements of both ETFs and carbon taxation.

These systems may place taxes on certain industries while enforcing general cap-and-trade policies over the rest of the economy. Or they may use a cap-and-trade system that has regulations in place preventing the price of carbon from going too high or low based on market variations.

Voluntary Markets

In addition to mandatory carbon trading markets, there are also a growing number of companies who are voluntarily seeking to offset their carbon emissions. Many of the companies and organizations taking part in the voluntary market are located outside of any compliance carbon market.

In voluntary markets, companies purchasing offsets can select and contribute funding to specific projects that remove carbon from the atmosphere in various ways, such as building renewable energy infrastructure, planting and maintaining forests, or installing systems to improve energy efficiency.

Each project sells carbon credits per ton of carbon emissions offset by that project. In the voluntary market, one can see a wide range of prices for each project that depend on many different factors:

Project Quality

One of the key factors that influence the price of a project’s credits is the quality of that project. There is a higher cost required to ensure that project benefits are real, long-term, and as great as possible, in addition to complying with necessary environmental and social safeguards. Projects that provide this quality assurance tend to have higher prices.

Project Size

Smaller scale projects are frequently more expensive to implement and produce fewer carbon offsets than larger projects. Because of this, credits are sold at a higher price to adequately compensate for implementation costs.

Project Location

The cost of projects in areas that lack resources and infrastructure can be higher as well because special considerations need to be made to work around these additional challenges. Many of these locations also benefit more from social and environmental developments, so the cost of the project is raised to allow them to move forward.

Project location is also a factor that can cause price fluctuations based on market demand. There is frequently a higher demand for locally based projects that contribute benefits to local communities, which can increase their cost because they are in higher demand from certain buyers.

Value of the Benefits

Many carbon reduction projects have additional community benefits, (or co-benefits,) outside of the carbon offsets. For example, a project that builds more energy efficient cookstoves has the intended benefit of reducing air pollution, but it also has the added co-benefits of improving quality of life and respiratory health for the households and communities using them. A project with a greater amount of additional benefits can be valued at a higher price.

These benefits are an important part of the vetting and approval process by the registries. The United Nations Sustainable Development Goals (SDGs) are the most common way of indicating these benefits. We list the SDGs applicable for each of our projects.

Differences in Emissions Reduction Methodologies

Sometimes even projects of the same type can have different prices because they use different methodologies. This could depend on local regulations or situations that require different approaches to the same kind of project.

Summary

There are a diverse range of factors that affect carbon prices, especially within voluntary markets. While all efforts to reduce carbon emissions are valuable contributions, it is important to consider a project’s quality and co-benefits in addition to price when deciding which projects to support.

Feel free to reach out to our team if you have any questions about the best kind of projects to contribute to for your preferences, budget, and carbon reduction needs.