BlogCarbon Pricing, Voluntary Carbon Markets (VCM)

No consensus on carbon markets at COP28

Written by

Ulf Narloch

Published on

COP28 in Dubai failed to advance on the implementation of market-based mechanisms to reach climate goals. Decisions on the rules for regulating carbon crediting under Article 6 of the Paris Agreement as supply-side pillar of international carbon markets were postponed. This also leaves the future of voluntary carbon markets unclear.

The promise of carbon markets

The 28th Conference of Parties (COP28) was a historic moment as it marked the first-ever global stock take to assess countries’ progress in meeting their climate goals as set by their Nationally Determined Contributions (NDCs).

These national goals are still not sufficient to limit global warming to 1.5° degrees as shown in synthesis report by Intergovernmental Panel on Climate Change.  Accordingly, UNEP’s emissions gap report and IEA’s Net Zero Roadmap highlight the need for more ambitious mitigation action.

For a net zero pathway, large investments of up to USD 45 billion per year in 2030 in energy systems and low-carbon infrastructure are needed. Especially developing countries, who historically have contributed least to emissions, lack the resources needed for such efforts.

International carbon markets have long been seen as one solution here. On the supply side, host countries would generate carbon credits through emissions reduction or removal projects. On the demand side, other countries or companies buy such credits to count them against their climate targets.

While some countries have already established regulated carbon markets at national or subnational level, currently the international exchange of such credits is unregulated via the Voluntary Carbon Market (VCM). Credits are generated through a variety of non-governmental schemes with their own methodologies and standards.

Lately, concerns for environmental integrity and lack of robust methodologies in these schemes have grown louder. An evolving UN framework for market-based mechanisms is supposed to address such concerns.

Already 129 countries have considered such market-based mechanisms in their NDCs. And also the recent World Bank status report notes an increasing momentum.  Yet this year’s COP failed to provide the guidance needed for high integrity carbon credits in international carbon markets.

Market-based mechanisms under Article 6

Article 6 is one element of the Paris Agreement from COP21. It sets the foundation for market-based mechanisms establishing countries’ right to authorize tradeable carbon credits in Article 6.2 and 6.4.

These articles have its origin in the Kyoto Protocol of 1997. Herein the Joint Implementation (JI) and Clean Development Mechanism (CDM) allowed countries and private sector entities to trade carbon credits internationally.

After years of negotiations on how to implement Article 6, a set of rules was agreed in Glasgow at COP26. Negotiations in COP28 were expected to finally lead to the implementation arrangements for Article 6 but failed to reach consensus.

Transferring mitigation outcomes

Article 6.2 allows for voluntary cooperation between countries to achieve their NDCs through Internationally Transferred Mitigation Outcomes (ITMOs). As per the NDC synthesis report 89 countries already plan to use this mechanism.

ITMOs are traded between two countries:

  1. A host country authorizes a generated carbon credit as an ITMO, whereby this country cannot count it anymore for their own NDCs
  2. Another country buys this credit to claim the mitigation outcome in its NDC
  3. A corresponding adjustments is made to avoid double counting in both NDCs

For this Article 6.2 mechanism to work, the process for authorization, the build-up of an international registry and reporting information and formats still need to be worked out. Yet draft texts on such arrangements were not adopted at COP28 for varying views on the role of the UN in this mechanism.

While negotiations are now postponed, discussion on bilateral agreements are expected to continue. For example, Sweden, Singapore, and UAE are actively seeking deals. Switzerland also became the first country to officially lay out its initial cooperative approaches under Article 6.2.

Crediting emission reductions

Article 6.4 establishes an international framework for the validation, verification, and issuance of high-quality carbon credits for Emission Reductions (A6.4ER). The NDC synthesis report shows that 59 countries communicated to use such mechanisms in their NDCs.

ER can be traded between companies:

  1. A project developer registers a project for accreditation of A6.4ER credits with a UN-led Supervisory Body
  2. These credits are bought by countries or companies; they can count the credit towards their climate targets only if authorized by the host country
  3. Via a corresponding adjustment the credit is not counted in the host country’s NDC if such an authorization is granted

Few days before COP28, recommendations on key issues to be solved under Article 6.4 were published, including carbon crediting methodologies and mitigation activities to be credited.

Despite this progress, the draft text on Article 6.4 failed to be pass at COP28.  Disagreement on the recognition of emissions avoidance and conservation enhancement activities from forests reflected an ongoing debate on the role of avoidance versus removal projects.

Demand for carbon credits

Notwithstanding increasing concerns and limited progress on these supply-side issues, demand for carbon credits continues to evolve from three directions.

Domestic compliance markets

Carbon credits can be counted towards the allowances in emission trading systems (ETS). Currently, 43 national or sub-national ETS are in operation or planned around the world.

Linking ETS from different countries can be one form of transferring mitigation outcomes under Article 6.2, but remains technically challenging.

In the past, ETS in the EU and New Zealand allowed for international carbon credits generated under CDM but stopped to do so to tighten the amount of allowances and to secure integrity.

Yet, some ETS allow for greater flexibility. South Korea allows credits generated in the country or by its companies.  Singapore has recently published a list of eligible international credits for domestic compliance.

CORSIA

Carbon credits can also be used to mitigate the climate impacts of hard-to-abate sectors which are not subject to national targets, such as aviation and shipping.

In 2016, International Civil Aviation Authority (ICAO) introduced the Carbon Offset and Reduction Scheme for International Aviation (CORSIA) allowing airline operators to buy carbon credits to compensate for their emissions.

After a pilot phase, from 2027 carbon offsetting will become compulsory for all international flights between defined state pairs.  Currently, 115 countries have announced their intention to participate in CORSIA.

A list of eligible emission units for the pilot phase until 2027 was defined by the ICAO Technical Advisory Body, including a variety of standards.

VCM

Carbon credits are increasingly sought by companies to meet their climate commitments, such as those set under the Science-based Targets Initiative. Where corporate emissions are not subject to domestic carbon pricing, these purchases are voluntary.

Currently, companies can rely on a variety of non-governmental schemes for carbon credits, such as the Verified Carbon Standard or Gold Standard, as the largest ones.

Yet lack of transparency on methodologies as well as greenwashing claims have been shaking up the VCM. According to the most recent State of the VCM report by Ecosystem Marketplace overall transactions in 2022 have halved to 250 MtCO2e from their peak in 2021 and are projected to fall further in 2023.

Yet prices remain at a higher levels than in 2021 indicating demand for high-integrity credits.

Pathway of international carbon markets unclear

Decisions on the implementation arrangements for Article 6 have now been postponed until COP29 in Baku, Azerbaijan. While bilateral negotiations on ITMOs are expected to continue, trade of A6.4ER credits are unlikely to happen any time soon before the international system and registry are in place.

Yet, carbon credits purchased by private companies do not need to go through Article 6 mechanisms. They can still build on non-governmental schemes in the VCM.

Yet it is to be seen if companies continue relying on such unregulated standards, when regulated credits through an UN-body become available. Consequently, the future of the VCM and its interaction with market-based mechanisms under Article 6 is uncertain.

Meanwhile, the corporate appetite for high-integrity credits is growing, as buying companies want to ensure that these really create the climate benefits they promise.

Several initiatives are working towards this end, as for example:

  1. Integrity Council for the Voluntary Carbon Market (ICVCM) setting core carbon principles (CCPs) for the supply of carbon credits
  2. Voluntary Carbon Markets Integrity Initiative (VCMI) launching demand-side rules for companies using carbon credits
  3. International Organization of Securities Commissions (IOSCO) publishing good practices for regulators and authorities for an orderly functioning of VCM

All these initiatives highlight the importance of building standardized methodologies and trust for VCM and market-based mechanism under Article 6 to unfold their full potential. Without these the offtake of international carbon markets may be long waited for.


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Photo by Boudewijn Huysmans on Unsplash