The 27th Conference of Parties (COP 27) to the United Nations Framework Convention on Climate Change (UNFCCC), held in Sharm-El-Sheikh, Egypt at the end of November 2022, saw the usual flurry of activity and intensive negotiations as many parties endeavoured to make progress on a diverse and complex range of issues and work towards the ultimate objective of the Paris Agreement, being the goal of keeping global warming to well below 2 (and preferably 1.5) degrees Celsius above pre-industrial levels. These negotiations took place under the shadow of significant macroeconomic and geopolitical uncertainty.
In what was pitched as the “implementation COP”, after the successes of COP 26 in Glasgow, it was generally considered by many participants that this COP would be the one to start the process of putting the agreed outcomes from Glasgow into action.
Given that it was a COP focussed on implementation, it is perhaps not surprising that there were relatively few breaking headlines. The most widely publicised headline of COP 27 was the progress made around the complex issue of Loss and Damage. We saw agreement on the creation of a dedicated fund, designed to compensate those countries that will be most impacted by the effects of climate change. Further details of this fund are expected in 2023 and more specifically, at COP 28 which will be held later this year in Dubai.
At Energex, we follow such events from the perspective of the carbon markets. More specifically, we are following the progress, at the UNFCCC level, around the development and operationalisation of the Article 6 mechanisms of the Paris Agreement. COP 26 in Glasgow saw a milestone achievement in this area, as the text for the Article 6 mechanism was finally agreed upon after several years of protracted negotiations.
The carbon markets, as they currently exist, are largely divided into “compliance” and “voluntary” markets. A compliance market, such as the EU Emissions Trading System (EU ETS) is a market that is regulated at a national or regional level and under which it is mandatory for a certain companies or installations to monitor and report their emissions, and to then to purchase and surrender allowances to cover those emissions. The EU ETS is an example of a “cap and trade” scheme, where emission reduction targets are achieved over time by a progressively tightening cap. The EU ETS has become the flagship tool for achieving decarbonisation objectives within the EU and is now set for significant expansion under the EU Fit for 55 package.
The voluntary market, however, is not a mandatory or indeed regulated market. Under the voluntary market, specific projects that remove or reduce carbon dioxide or other greenhouse gases (GHGs) such as methane, are issued with carbon credits by various standards bodies, such as VERRA or Gold Standard. These carbon credits are traded and bought by corporates and other entities who wish to use them to offset their hard-to-abate or residual emissions. The voluntary market enables the development of carbon reduction and removal projects through climate finance and technology transfer, enabling the development of projects that would otherwise not take place.
Article 6 of the Paris Agreement, and more specifically the Art 6.2 and 6.4 mechanisms, are of interest to carbon market participants because they are the mechanism through which carbon markets will be used to achieve the ultimate objectives of the Paris Agreement.
Article 6.2 will enable countries and governments to transfer Internationally Transferrable Mitigation Outcomes (ITMOs) between themselves, therefore transacting carbon at a national level, to manage their commitments to their Nationally Determined Contributions (NDCs) under the Paris Agreement. We have already witnessed, in the closing few weeks of 2022, that several countries have announced the use of this mechanism. For example, the deal announced between the governments of Ghana and Switzerland for the transfer of an ITMO, accounting for the emission reductions generated by a Ghanaian project, and to be used against Switzerland’s NDC to the Paris Agreement. These early Art 6.2 transactions should pave the way for a flurry of further activity in 2023.
The Article 6.4 Mechanism, which is largely regarded as the successor to the Clean Development Mechanism under the Kyoto Protocol, will be a mechanism for enabling non-government actors to participate in the carbon markets, through the use of tradeable emissions credits. This mechanism, it is anticipated, will involve a centralised registry to issue, track and surrender carbon credits, much like as existed under the CDM of the past, and will therefore create a market in which the private sector can actively participate.
The task for designing and implementing the Article 6.4 mechanism has been passed to a recently formed Supervisory Body. This Supervisory Body met at COP 27 with an ambitious work plan for the implementation of the new mechanism. They have made good progress to date, but the bulk of their work has been scheduled for the year ahead and the run-up to COP 28 in Dubai.
We anticipate that the development of the Article 6.4 mechanism will lead to the formation of a “quasi-compliance” market, whereby the use of offsets for voluntary purposes can have an impact under the accounting framework of the Paris Agreement. This will be the case where a carbon credit has been issued with a so called “Corresponding Adjustment”, ie where a host country and a retiring country make an accounting adjustment in their respective emissions records, to take into consideration the emissions reduction or removal associated with a specific carbon credit.
However a number of questions remain about how the Art 6 mechanism will work alongside the Voluntary Carbon Market as it exists in its current form.
The independent standards that exist in the voluntary market today have enabled the voluntary carbon market to grow and will continue to have a significant role to play in the future. Indeed the vast majority of carbon credits currently in circulation are issued by a handful of issuing bodies that provide the framework and guidelines under which carbon reduction and removal projects operate.
Several initiatives are also underway to assist buyers of carbon credits to examine the quality of the credits they are buying, such as the Integrity Council of the Voluntary Carbon Markets (ICVCM) who is currently developing the Core Carbon Principles (CCPs) to help identify what may constitute a “good quality” carbon credit, and the Voluntary Carbon Markets Initiative (VCMI) who are providing guidance on the types of claims carbon credit buyers should make.
There is, therefore, understandably some confusion for the time being as to how these various organisations and mechanisms interact and how they will operate going forward as the market develops.
What is clear is that we are entering a period of significant development and growth for Carbon markets, both compliance and voluntary, and that 2023 will be a critical year as we head towards the next COP in Dubai in December. We at Energex believe that markets will play a key role in achieving decarbonisation objectives and the net zero goals that are being set across many sectors of the economy.
If you would like to understand more about the Carbon Markets, the evolving regulatory landscape and opportunities for business, please reach out to Michael Fulton at Energex Partners mfulton@energex.partners.
Written by Michael Fulton