What is Carbon Finance?

As a branch of environmental finance, carbon finance is a discipline dedicated to financial matters relating to the fight against climate change. The changing climate has great implications on the financial health of the world. As a result, carbon finance explores the significance of this adverse change in climate and seeks to continue to identify ways of curtailing this issue. Carbon finance also offers opportunities for profits through carbon trading, which can also be an incentive for many people to get on board to combat climate change.

As a way to help arrest global warming, carbon finance is principally a market-based approach. Experts on the subject have asserted that carbon dioxide and other greenhouse gas (GHG) emissions are threatening the long-term sustainability of economic activity, among other things. Accordingly, carbon finance is perceived by many as one of the solutions to aid climate control. It mainly revolves around carbon markets where the trading of carbon credits take place in a similar manner to other financial instruments.

Carbon credits are a type of monetized instruments in the carbon market. These credits permit the users to emit a certain amount of carbon dioxide, and they can be awarded to those who make more GHG emission reductions than is required. In this instance, the holders of the credits can choose to sell them to those who need to emit more GHG than is allowed them by regulation. The medium where this carbon credit trading takes place is the carbon market, which is mostly accessed through specialized brokers, clearing agents or exchanges.

Furthermore, the World Bank Carbon Finance Unit (CFU) is one of the major players in the fight against climate change. The CFU provides grants to certain parties wishing to purchase carbon credits. Also, governments and national and international regulating bodies demand that producers and consumers emit lower amounts of GHG. To implement climate control plans, they have established yearly targets for GHG emission reductions. One way they aim to achieve this is by allocating allowable GHG emission caps to certain industries and companies.

These caps tend to affect some companies financially because they might find it hard to remain profitable while remaining within their allowable caps. One way that companies counter this is by purchasing carbon credits from another party who has made more reductions than required. Depending on circumstance, it could be cheaper to make reductions or to buy credits, so companies will choose the solution to fit their specific needs.

This field of environmental finance is tightly connected to the evolution of alternative energy sources. Fossil fuels, such as crude oil and coal, are blamed by many people for the global warming issue. This makes the other energy sources attractive because they are inherently different. Thus, carbon finance also seeks ways of making these sources widely available, which can contribute to climate control.

The carbon market has also attracted traders, hedge funds, venture capitalists and many other financial players. For these investors, carbon finance provides another asset class that they can consider for their portfolios. They typically use various instruments, including carbon dioxide emission futures and spot contracts, weather-based call options, put options and swaps, as well as other instruments that are derived from the value of the carbon credits. Furthermore, the private-sector investors can pool resources to form a carbon fund that manages a portfolio of carbon securities.