Eli5:- Carbon Credits. Why do they exist? What’s their purpose? How do they work? Is it a fad?

Question

Companies are talking about their ESG efforts, and I’ve noticed this term appearing a few times now.

In: 13

Answer 1

2 answers:

First, the “How it’s supposed to work” answer: They are trying to apply the power of “capitalism” to the carbon emission reduction initiatives. And I use the quotes because it’s not really a free market since it would have to be government mandated. But basically the government would say “Company X, you are allowed to produce X tons of carbon emissions”. Company X is currently producing Y tons of carbon emissions, and Y > X. Call the difference Z. So instead of making the massive capital investment that may be required to lower Y and eliminate Z, they could purchase “Carbon Credits” to offset the difference.

The Capitalism part comes in because these Carbon Credits could be bought and sold on an open market. And it allows for a new kind of company to emerge, a company that does nothing but accumulate Carbon Credits via carbon emission reduction activities, and then sells those credits to the companies exceeding their allotted carbon quota. So they net impact to the planet is 0.

Second, the “why companies actually talk about this in their ESG reports” answer: It allows companies to advertise/virtue signal to their ESG driven institutional investors that they “care about the climate” and are “fighting the climate crisis” by just writing a check vs actually investing in anything actually substantive that would lower their carbon emissions because that would cut into their profits.