Like any other commodity a carbon credit’s price will depend upon the supply and demand for it in the particular market that it is useful for. Each carbon credit price will be influenced by a multitude of factors but ultimately the price will depend on the level a buyer is willing to pay and the seller willing to accept for it at a specific moment in time. Some credits are homogenous ensuring their fungibility and a value being the same wherever or however it is traded. For example a European Union Allowance (EUA) will trade at or around the same price wherever the trade takes place, be it on different exchanges or OTC, because if there is a price difference it will be arbitraged away until the different market places equalise. Other carbon credits , such as VER offsets, have a wide variety of characteristics (e.g. produced by different technologies in different countries to different issuance standards) that cause their price to vary widely. Such carbon credits are therefore not fungible and the traded price of one kind of VER is of limited utility when determining the value of another.
Typically, the main compliance allowances used in each ETS have good liquidity (low bid / offer spread, good market depth, low cost of transaction etc.) as they are the main ‘currency’ used within each system and as such are fungible allowing traders to know they are all buying and selling the same thing. A well designed ETS will also be characterised by a traceable price history and a large number of participants entering the market from both the supply and demand sides. Trading will also usually take place on a regulated exchange ensuring standardised products and secure settlement.
To the extent that offset allowances can be used for compliance they will all have similar characteristics and thus they too can become fungible and a transparent carbon credit price will emerge. However, limits imposed on their use for compliance will limit the demand for offsets which will hamper price development. This is particularly apparent if the supply side is considerably larger than demand (that will cause very low prices) or of similar size (that will cause their price to track the main carbon credit currency of the ETS very closely). It is possible that even in compliance markets offset project technology type, country of origin and other environmental & social benefits will play a part in price determination. Offset projects with greater environmental and social benefits are typically in more demand than the rest, either from the compliance market itself or from Corporate Social Responsibility carbon footprint offset programmes. Consequently, there can be large price variations from one allowance to the next. Specialised offsets typically trade in the Over the Counter (OTC) markets due to the non-standard nature of trades which makes them less suitable for exchange based trading.
Voluntary carbon credits have no defined minimum specification and therefore there is little possibility for standardisation and liquidity to develop. Without standardisation pricing information, if it is ever published (OTC markets tend to be more opaque), is of limited utility when trying to determine the price at which another VER will trade. The VER market has a much wider variety of perceived qualities, a large supply side and limited demand and so liquidity (as defined above) is almost non-existent.
For more information on how the value of currencies (e.g. EUAs) used by the various compliance markets is expected to evolve, please see Carbon Market Research page.
