The landmark Paris Agreement on global climate change was reached in 2015, but 5 years later, Article 6 of the Agreement has not yet been finalized. Article 6 sets out the rules for how countries can reduce their greenhouse gas (GHG) emissions using international carbon markets. International carbon markets are important because they can reduce the costs of climate action by billions of dollars every year [1]. In our last blog, we provided an overview of the three separate Article 6 mechanisms and explained why the Article 6.4 mechanism is the most relevant to the private sector [2]. In this blog, we discuss the key issues with Article 6 that are preventing countries from reaching a consensus on this critical piece of the Paris Agreement.
Issues with Article 6
Article 6 of the Paris Agreement has proven to be contentious. Part of the reason for this is that the Agreement contains a certain level of “constructive ambiguity”. The use of constructive ambiguity led to a mechanism with limited international oversight making the operationalization a challenge [3]. So what are the key issues if Article 6? We discuss six of the most significant issues here.
Double-counting
Perhaps the single biggest point of contention among parties is the issue of double-counting. The Pairs Agreement will require that countries make corresponding adjustments when a buyer and seller exchange Internationally Transferred Mitigation Outcome (ITMOs). If no corresponding are adjustments are made, both the party selling the credits and the party buying them could use the same emission reduction towards their targets. Corresponding adjustments ensure robust accounting and the avoidance of double counting. Despite this fairly straight forward rationale, some nations do not support the accounting adjustment for the host nation. For example, Brazil would like to sell emissions reductions resulting from rainforest conservation activities to other countries, but would also like to take credit for these same actions. This position is strongly opposed by the European Union and others.
It is hard to see how double-counting can be avoided without a corresponding adjustment being made, but this issue continues to be a sticking point in international climate negotiation. Fortunately, a solution to the impasse may be at hand. The offsetting certification body Gold Standard has stated that is plans to differentiate post-2020 (i.e. Paris-era) carbon credits depending on whether host nations make a corresponding adjustment to their national emissions inventories. This could force offset purchasers to drastically rethink their voluntary climate strategies. If there is no demand for credits from nations that do not make a corresponding adjustment, host nations will be forced to make the adjustment in order to successfully market their carbon credits. This is proof that voluntary markets play an integral role in shaping compliance programs [4].
Kyoto-era projects, methods, and carbon credits
Article 6.4 would create a new international carbon market that would replace the Clean Development Mechanism (CDM), which was created under the Kyoto Protocol (the predecessor to the Paris Agreement). As a result of the transition away from the CDM, there is a divergence of views on allowing CDM methodologies, projects and carbon credits into the new Article 6.4 credit market. While the Paris Agreement encouraged the voluntary cancellation of CDM credits, some nations have fought to keep these credits alive. In particular, countries such as China, India, South Korea, Brazil and Mexico which generate the majority of CDM credits, would like to see these credits transition to Article 6.4 credits. It is estimated that 3-5 billion of these credits exist and another 5 billion could be created if market prices were to increase [5].
So why not allow CDM credits under Article 6.4? The primary pushback on this proposal is due to the fact that these credits are not viewed as being credible. In other words, there is little evidence that these credits actually represent a real emission reduction that would not have occurred in the absence of the offset revenue. This assertion is supported by market data as CDM credits currently trade at $0.20/tCO2e. This miniscule amount of carbon revenue is hardly enough to support the development of the emission reduction activity. If the emissions reduction activity occurs without any significant offset revenue, is it really an emissions reduction? Or is it simply a business-as-usual activity?
One of the potential compromises that has been proposed is to allow for Kyoto-era CDM credits under the Article 6.4, but with a vintage restriction (i.e. only allow credits after a certain date) or a geographical restriction (i.e. allow for only the least developed countries to carryover CDM credits). But CDM credits are not the only type of carbon credit from Kyoto-era programs. The Kyoto protocol also allowed countries that overachieved their emissions targets to sell Assigned Amount Units (AAUs) and Joint Implementation (JI) credits from projects that are carried out in countries that are signatories to the Kyoto protocol (as opposed to CDM credits that come from projects in developing countries that did not have a reduction target under the Kyoto protocol). What happens to these credits? Australia has said it intends to make use of its AAUs under the Paris Agreement. Actions like this could significantly undermine the Article 6 mechanisms as there are 15 billion AAUs floating around and many of these were generated as a result of weak targets that were easily met without significant climate policy.
Single or multi-year targets
Under the Paris Agreement, countries must set their own climate target which is referred to as a nationally determined contribution (NDC). These NDCs can be based on an emissions budget across multiple years, but most are based on single-year targets. For example, Canada has committed to reducing emissions by 30% relative to a 2005 baseline by 2030. Single year targets are less robust than multi-year targets. It is the cumulative total emissions over time that ultimately matters. A single year target can result in a large purchase of credits during the target year while taking little action up to that point in time. While there is no single standard for the structure of a target, several options have been proposed [6]. These options are outlined in Figure 1.
Figure 1 – Options for structuring country-level targets
Emissions reductions outside of a country’s target
Countries can only generate Article 6.4 credits for emissions that fall outside the scope of its NDC. Emissions that are within the scope of the NDC simply count towards the countries own emissions reduction target and if the NDC is exceeded, an Article 6.2 credit can be created. This creates an incentive for countries to limit which sectors the NDC applies to (so that Article 6.4 credits can be created) and the ambition of the NDC (so that the NDC can be exceed and Article 6.2 credits can be created). For example, a country may exclude agriculture from the scope of its NDC so that any reductions that occur in that sector can be sold to other countries under the 6.4 mechanism. This issue highlights a broader concern in the bottom-up approach to setting NDCs under the Paris Agreement: there is no uniform structure to setting climate goals and all countries face the free rider dilemma [7].
Overall Mitigation in Global Emissions (OMGE) provision
Article 6.4 also requires that projects must result in an “overall mitigation in global emissions” (OMGE). OMGE means that mitigations should be additional (i.e. go beyond what would have happened if the trading scheme had not been in place) and should avoid carbon leakage (i.e. the shifting of activities and GHG emissions to another location or country). Some have suggested that additionality alone is insufficient to deliver OMGE and that the provision should ensure a net reduction in emissions, rather than just offsetting GHG releases between countries. A report by Lambert Schneider and NewClimate Institute offer several options that can be used to ensure OMGE [8]. These include:
- Automatic cancellation of credits when transferred or created
- Discounting of credits at the point of creation
- Mechanism itself ensures overall mitigation
- Conservative baselines
- Limiting the crediting period
- Voluntary approaches such as the cancellation of credits
Share of the proceeds provision
The “share of the proceeds” provision (stated in Article 6.6) states that a portion of the value of any Article 6.4 credits would be paid into an Adaptation Fund that supports climate change resilience-building efforts in developing countries. A similar system is already in place under the Kyoto Protocol’s Clean Development Mechanism. Two percent of the value of any “certified emission reductions” (CERs) must be set aside to cover administrative costs and a fund a climate adaption fund. The Paris Agreement has carried over this levy for all Article 6.4 credits, but some countries (particularly developing countries that stand to benefit from an adaptation fund) would like to see this levy expanded and extended to Article 6.2 credits.
Conclusion
Without a global market mechanism under Article 6.4, GHG mitigation cost would be higher, but the Paris Agreement could live on. The real risk is that there is no agreement on an Article 6.2 bilateral trading mechanism. Without a set of internationally recognized rules, countries could just make up their own rules. This could quickly lead to the breakdown of transparency and trust in the global agreement.
While there are many issues to sort out before Article 6 of the Paris Agreement is finalized, these challenges are not insurmountable. Arguably, the largest barrier has already been overcome: getting most of the world to sign the Paris Agreement in the first place. We believe that an internationally recognized carbon market is a matter of if, not when. Driven largely by the investment community, there has been significant momentum on climate action in recent years. This is a trend that is likely to persist. Given this view, industry should begin today to position itself for world with global carbon trading. This means developing core competencies in GHG accounting, management, and project development. Early actors are likely to gain a competitive advantage in this nascent space. The future awaits.
References
[1] https://www.iisd.org/sites/default/files/publications/status-article-6-paris-agreement.pdf
[2] https://mailchi.mp/e5fbf61f68e5/paris-article-6-part-1
[3] https://www.tandfonline.com/doi/abs/10.1080/14693062.2019.1599803
[4] www.carbon-pulse.com/101914
[5] https://www.oecd-ilibrary.org/environment/markets-negotiations-under-the-paris-agreement_99d9e615-en;jsessionid=bM7PZz6FXAl6_KLvlYI2cu2a.ip-10-240-5-81
[6] https://www.carbonbrief.org/in-depth-q-and-a-how-article-6-carbon-markets-could-make-or-break-the-paris-agreement
[7] https://www-docs.b-tu.de/fg-energiewirtschaft/public/Veroeffentlichungen/A_Note_on_Climate_Policy_Negotiations.pdf
[8] https://newclimate.org/2018/11/21/operationalising-an-overall-mitigation-in-global-emissions-under-article-6-of-the-paris-agreement/