As delegates arrive in Madrid for the UN Climate Change Conference (COP25) this week, one issue is top-of-mind: finalizing the rules on how countries can reduce their emissions using international carbon markets, covered under Article 6 of the Paris Agreement on climate change.
Article 6 is one of the least accessible and complex concepts of the global accord. This complexity was a major reason that Article 6 was not agreed to until the last morning of the Paris negotiations in 2015 and was left unresolved at the Katowice climate talks last year. Getting these rules right is critical for fighting climate change: depending on how they are structured, Article 6 could help the world avoid dangerous levels of global warming or let countries off the hook from making meaningful emissions cuts. The integrity of the Paris Agreement and countries’ climate commitments hang in the balance.
Here’s what you should know:
How do international carbon markets work?
International carbon markets work like this: Countries that struggle to meet their emissions-reduction targets under their national climate plans (known as “nationally determined contributions,” or NDCs), or want to pursue less expensive emissions cuts, can purchase emissions reductions from other nations that have already cut their emissions more than the amount they had pledged, such as by transitioning to renewable energy. If the rules are structured appropriately, the result can be a win-win for everyone involved — both countries meet their climate commitments, the overachiever is financially rewarded for going above and beyond, finance is provided to the country generating the emissions reductions, and the world gets a step closer to avoiding catastrophic climate change.
What does the Paris Agreement say about carbon markets?
Article 6 has three operative paragraphs, two of which relate to carbon markets:
- Article 6.2 provides an accounting framework for international cooperation, such as linking the emissions-trading schemes of two or more countries (for example, linking the European Union cap-and-trade program with emissions-reduction transfers from Switzerland). It also allows for the international transfer of carbon credits between countries.
- Article 6.4 establishes a central UN mechanism to trade credits from emissions reductions generated through specific projects. For example, country A could pay for country B to build a wind farm instead of a coal plant. Emissions are reduced, country B benefits from the clean energy and country A gets credit for the reductions.
- Article 6.8 establishes a work program for non-market approaches, such as applying taxes to discourage emissions. For this explainer, we will focus on the carbon markets elements of Article 6.
While Article 6 established these concepts in broad strokes and countries achieved some progress on defining the rules over the years, their final shape remains yet to be agreed. Finalizing these rules is a key agenda item for COP25.
What benefits could carbon markets offer if rules are designed well?
Carbon markets are a big deal, both in terms of potential emissions reductions and the cost savings they can generate. Half of countries’ initial NDCs (constituting 31% of global emissions) include the use of international cooperation through carbon markets. According to IETA, the potential benefits to cooperation under Article 6 include cost savings of $250 billion per year in 2030.
International cooperation through carbon markets can bring additional public and private finance and catalyze emissions reductions in a country hosting the mitigation activity. And for purchasing or acquiring countries, using carbon markets enables access to a wider pool of opportunities to reduce emissions. This might lead to higher ambition, given that mitigation can be made more cost-effective, which provides flexibility.
What are the biggest risks if rules on international carbon markets are designed poorly?
Without the right rules in place, Article 6 could actually weaken countries’ NDCs and increase global emissions. There are a few ways in which this could happen:
- Double-counting: For example, country A might build a wind farm and then sell the credits for those emissions reductions to country B, so now country B can count those emissions reductions as part of its progress to achieving its NDC. But if country A claims those same emissions reductions toward achieving its own NDC, that is double-counting. While the Paris Agreement is clear that double-counting must be avoided under Article 6, the extent to which double-counting is actually avoided depends on how accounting rules are operationalized. If emissions reductions are double-counted, it will potentially result in an increase in global emissions and weaken the already inadequate NDCs.
- Additionality: The way in which Article 6 is finalized will dictate whether emissions reductions under Article 6 will be additional to what would have occurred anyway. For example, if country A was already going to build that wind farm instead of a coal plant, here the carbon market didn’t offer a climate benefit. Without guidance ensuring additionality of emissions reductions, Article 6 rules could weaken NDCs.
- Failing to deliver increased ambition and progression: Article 6 can be designed in a way that either supports or hinders increased ambition -- for example, by determining whether subsequent NDCs will be incentivized to increase coverage of GHGs and sectors over time, and whether transfers of emissions reductions will result in greater emissions cuts.
Which are the most contentious issues that will likely be negotiated by ministers at COP25?
There are likely four of them:
Avoiding double-counting: Countries were clearly concerned about double-counting at COP21 in Paris; the need to avoid it is mentioned no less than seven times in the Paris Agreement and its accompanying COP decision (decision 1/CP.21). The Paris COP decision specifies that double-counting in Article 6 must be avoided on the basis of a “corresponding adjustment” – a term you’ll hear often at COP25. A corresponding adjustment means that when one country sells emissions reductions to another, it must adjust its own emissions figures accordingly. In other words, it must increase its level of emissions reductions in its NDC to make up for the fact that it sold some emissions reductions to another country. Conversely, the country that purchased the credit adjusts its own emissions reductions downward.
There are several critical issues in the negotiations about when corresponding adjustments apply and how to avoid double-counting. One of the largest issues that countries disagree on has to do with whether corresponding adjustments will be required from credits from specific projects under Article 6.4. For example, credits from an emissions-reduction project like a wind farm could be sold to another country, and then the country that pursued the emissions reductions may choose to also apply those reductions towards achieving its NDC. If there’s no corresponding adjustment, the emissions reductions of that project are counted twice.
Overall mitigation in global emissions: Article 6.4 stipulates that the mechanism is to deliver an “overall mitigation in global emissions” (often referenced as OMGE). For some Parties, overall mitigation in global emissions could mean that some of the credits generated under Article 6.4 for emissions reductions are essentially taken off the table, not used toward any Party’s NDC. In other words, rather than transferring them between Parties and allowing a buying country to count those emissions reductions toward its target, these unused emissions reductions could be set aside to provide a net decrease in global emissions. For example, if 10 credits were generated from country A’s wind farm, intended for transfer to another country, some percentage of the 10 credits would not be applied to either the NDC of country A or a purchasing Party. In this case, Article 6 would not simply be an offsetting tool, in which emissions reductions are transferred from one country to another with no guarantee of additional emissions cuts beyond the NDCs, but rather a tool that contributes to further emissions reductions. Countries are primarily divided on whether overall mitigation in global emissions applies only to Article 6.4 or to Article 6.2 approaches as well, as well as how overall mitigation in global emissions is done in practice (via discounts, cancellations, or other means).
Share of proceeds: Under the Kyoto Protocol, a levy was placed on trades under the Clean Development Mechanism, and the resulting proceeds were used for administrative purposes and to replenish the Adaptation Fund, which provides support to vulnerable countries to adapt to the impacts of climate change. The Paris Agreement was explicit about continuing this support for adaptation and administrative purposes under Article 6.4 (trading credits from emissions reductions resulting from specific projects), but did not mention it in Article 6.2 (when two or more countries transfer emissions reductions, for example through linked emissions-trading schemes). In Madrid, countries will grapple with how the share of proceeds under Article 6.4 will be carried out and whether there will be a share of proceeds from Article 6.2 transfers to generate revenue for the Adaptation Fund.
Carryover of pre-2020 Kyoto Mechanism units: Another issue is whether countries can use credits generated under the Kyoto Protocol prior to 2020, which remain unused given a lack of demand. A recent study estimated that there could be as many as 4 billion such units leftover from the Kyoto Protocol, representing 4 gigatonnes of emissions. If countries take full advantage of these credits towards achieving their already insufficient NDCs, the world will get even further off track from reaching the goals of the Paris Agreement.
Getting the Rules Right
Studies show that if designed well, Article 6 has the potential to contribute to the Paris Agreement’s goals at a lower cost. It can also provide great incentive for private sector investment in various countries and could help some countries leapfrog their technological development. But all of this can only occur if the market is credible, reliable and has integrity. Depending on how these issues are resolved in the negotiations, Article 6 could either deliver this ambition or fail dismally. If it fails, the intent and purpose of national commitments under the Paris Agreement will be seriously undermined.
The negotiations in Madrid can build on the substantial progress made at COP24 in Katowice, as well as the intensive diplomatic and technical effort over the last year to get us to a better place. However, most importantly, countries must resist the urge to just tick the box on getting the Article 6 rules done — they need to get them done right. Article 6 must aid — rather than undermine — the ambition and environmental integrity of the Paris Agreement and countries’ commitments under it.