The 1997 Kyoto Protocol was supposed to herald a brave new future – a world in which global warming would be tackled head-on through a mechanism known as carbon trading.
The principle was simple: countries would each be set a cap on the amount of carbon dioxide (CO2) and other greenhouse gases they could produce.
If they managed to undercut the cap by producing fewer emissions, they could sell their surplus capacity.
At national level, individual governments had the choice as to how to distribute their carbon quota: they could issue free permits to companies, or they could auction them off. Companies could then trade any surplus quotas on the open market.
This would allow flexibility in the system, while still encouraging companies to reduce emissions.
Favouring the rich
The Kyoto Protocol took effect from 2005 to give countries time to reduce emissions to roughly 95% of their previous level, and the first trading period ran until 2007. Subsequent trading periods have steadily reduced carbon caps.
The deal was criticised for favouring the big industrialised nations, as the cap was based on their historic level of greenhouse-gas emissions. It was claimed the cap made it harder for developing nations to develop an industrial infrastructure.
Despite this bias toward the developed world, the US refused to sign up to the agreement, claiming it would damage business.
For the trading scheme to work, it was important the ‘carbon credits’, based on the right to emit one tonne of CO2, had a value. However, in some cases so many permits were issued it devalued the whole system.
One of the first carbon trading schemes was the UK Emissions Trading Scheme, which ran from 2002 to 2006, before merging with the European Union Emissions Trading Scheme (EU ETS).
The EU ETS is the world’s largest trading scheme, and in its first year of operation in 2005, 362m tonnes of CO2 were traded on the market for €7.2bn.
The price of credits, or ‘carbon price’, originally peaked at roughly €30 per tonne. However, in 2006 the price plummeted to little more than €1 per tonne after several EU countries easily met their emission targets. In 2007 the volume of surplus allowances saw the price drop even further to €0.10 per tonne.
A second trading period ran from 2008 to 2012, and for the first time it included aviation emissions. The price rose to an average of €22 per tonne in 2008 before falling back to roughly €13 per tonne in 2009.
The third phase, which runs from 2013 to 2020, saw the setting up of an overall EU cap, with permits then allocated to member states, and a move towards auctioning credits. The cap proposed for 2020 represents a 21% cut in greenhouse gases compared with 2005.
Can you invest in carbon credits?
There are a number of ways individuals can invest in carbon credits, either through certified schemes or by directly buying and selling carbon futures.
Among the financial vehicles that can be traded are carbon credit certificates, voluntary emission reductions (VERs), certified emission reductions (CERs) or collective investment schemes (CIS).
Some companies are also advertising the chance to invest directly in an environmental project that generates carbon credits.
One bona fide certification body, The Gold Standards Foundation, was set up in 2003 by the World Wide Fund for Nature (WWF) and others to help ensure environmental projects deliver genuine reductions in greenhouse gases.
However, while some carbon-credit financial products are Gold Standard certified, the organisation warns they are complex investments and difficult for personal investors to evaluate.
It says: “If you need to sell your carbon credits at any given time, you should be aware that your ability to do so will be contingent on the state of the secondary trading market, which is affected by various global political and economic factors that are beyond The Gold Standard Foundation’s control.”
‘Dubious sales tactics’
A 2016 briefing from the UK’s Financial Conduct Authority (FCA) also warns that investors in carbon credits have found it hard to sell them, and none have reported making a profit.
“This supports our view that there is not a viable secondary market for ordinary investors to sell or trade carbon credits, despite claims and promises made by many firms, advisers and brokers promoting and selling them as an investment,” says the FCA.
The regulator says it has received reports that an increasing number of firms are using “dubious, high-pressure sales tactics” to sell carbon credits to investors.
The briefing says potential investors are often called “out of the blue” by sales people, although carbon credits are also marketed through seminars and exhibitions.
Unable to sell
“The caller may claim carbon credits are ‘the new big thing’ in commodity trading… but we have seen that investors are not making any money as they cannot sell or trade their carbon credits,” adds the FCA.
“Trading on carbon credit markets requires skill and experience, and we strongly advise you to get independent professional advice before handing over any money.”
The FCA does not regulate the sale of carbon credits, so even though some of the firms selling them may be FCA registered, there is no oversight or right to complain through the Financial Ombudsman Service or the Financial Services Compensation Scheme.