Towards a global carbon market: how full is the glass after the deal on Article 6 at COP26?
Highlights from the online debate "What prospects for the global carbon market after COP26?"
This FSR Debate, which took place on 9 December 2021, reviewed the outcomes of the UN Climate Conference (COP26) in Glasgow, focusing on the agreement reached on Article 6
Opened by Ilaria Conti (FSR), and co-moderated by Prof. Alberto Pototschnig (FSR) and Prof. Simone Borghesi (FSR), the debate highlighted the implications of the progress made at COP26 for developing the global carbon market with speakers directly engaged in the negotiations and working on the analysis of international carbon markets and cooperation on climate policies. It also touched upon the possible reforms and mechanisms enabling the linking of emissions trading systems (ETSs), the centre of attention of the project LIFE DICET, co-financed by the LIFE Programme.
Martin Hession from DG Climate Action reminded the audience that the text implementing Article 6 took six years to be agreed upon. In view of this, he considered the agreement a balanced and fair outcome on the implementing rules, with much welcomed corresponding adjustments (CA), new mechanisms to replace the Clean Development Mechanism (CDM) aligned with the Paris goals and ambition. For the first time, compulsory levies (shares of proceeds) on the trade of credits will support adaptation and finance efforts in developing countries. It shows that a multilateral process can deliver ambitious and robust rules and overcome the limitations of the Kyoto Protocol. All this came at the cost of a compromise, including the carryover of the CDM units under Article 6 during the first implementing phase of Nationally Determined Contributions (NDCs).
The second intervention by Stefano Verde (FSR) was focused on “ETS Alignment: possible reforms for integration”, a question addressed by the project LIFE DICET. While this research project is only indirectly linked to the outcome of COP26, it can provide insights for future cooperation among Parties to the Paris Agreement. A growing number of ETSs will be linked indirectly through Article 6.4, while some may use Article 6.2 to account for the trade of their mitigation outcomes through linking. Under the right conditions, ETS linking helps achieve efficiency gains. This, in turn, can be used as a lever to increase ambition or to save costs. Jurisdictions can pursue different actions to facilitate linkages between ETSs that are not limited to ensuring an overlap of acceptable price ranges and a linking agreement including provisions for environmental integrity as well as minimum and maximum price bounds (a price collar).
How full or empty is the glass after COP26?
To kickstart the discussion, Simone Borghesi asked the panellists how full or empty they would see the glass after COP26, noting that Prof. Rob Stavins considered it as a three-quarters full glass in a recent interview.
Luca Lo Re from IEA recognised it was already a success to obtain an outcome. After five years, a political compromise was found, demonstrating a sincere political will to go forward and set the basis for a new start. The quality of the outcome can be valued in different ways. The deal on Article 6 offers a good accounting framework, along with corresponding adjustments for Internationally Transferred Mitigation Outcomes (ITMOs). In addition, the agreement recognises the role of host countries in approving the use of credits under 6.4 for compliance. Luca Lo Re also welcomed the ban on the banking of ITMOs between NDC implementing periods and the stringency of baseline settings and additionality. However, the picture is not final: more time is needed to set the implementing rules, to understand all implications of the agreement, to observe Parties’ good and bad practices and to understand the interplay with the voluntary carbon markets (VCM).
Similarly, Kelley Kizzier from the Environmental Defense Fund sees the deal as a success. According to her, the three-quarters full picture of Rob Stavins is accurate: obtaining that after six difficult years is a roaring success. She sees positively that ITMOs for compliance have to be accounted for (CA) and that credits under 6.4 need to have the authorisation of the host country to be valid. The text also set a pathway for accounting for VCM. Unfortunately, the one-quarter empty is the CDM units carryover from 2013 onward, whose impact is unknown but limited to the first NDC period.
Billy Pizer from Resources for the Future underlined three main points. Firstly, purchasing jurisdictions will be under a lot of scrutiny regarding the type of credits they buy. Secondly, the increase of climate ambition will trigger an increase in carbon prices. However, carbon pricing increases the costs of goods more than other sorts of regulation: this makes it efficient in changing behaviours, but it can create trade tensions and trigger redistribution issues. Thirdly, when jurisdictions consider linking, a lot of harmonisation is needed, including an implicit or explicit price agreement. However, this will still trigger a lot of redistribution. As such, linking is more probable between jurisdictions with a lot in common. He suggested that Article 6.4 may be the most used and that jurisdictions would create the framework to get the right project-based crediting issued and used for compliance.
The audience’s view
Polls for the audience nourished the discussion among the panellists. When asked about the means Parties to the Paris Agreement should prioritise to achieve the targets in their own NDCs, both the audience and the speakers agreed on the need to focus primarily on domestic actions and to a lesser extent on international cooperation under Article 6. In fact, Parties cannot forego domestic measures, and international cooperation provides a way to go beyond what needs to be done internally. This represents a complete U-turn compared to what some Parties considered in 1997: one jurisdiction cannot buy its way out, there is much less expectation on what to do somewhere else. The audience agreed also with the speakers that the Agreement on Article 6 at COP26 was a good deal (80% of the respondents were satisfied while 20% were neutral).
The picture was different when it came to establishing through the third poll whether Article 6 would be a gamechanger for emissions reduction at the global level. Within the audience, 25% of the respondents rather agreed with the statement, 38% were neutral, 25% rather disagreed, and 13% stated they did not know. Panellists would tend not to define Article 6 as a “game-changer”: Article 6 can increase the ambition, but the main contribution to emissions reductions derives from the NDCs.
One last question covered in the discussion was on how Article 6.4 and VCM can increase climate ambition. On the one hand, most speakers sought to reassure that it is not in a country’s interest to sell its cheap emissions under Article 6.4 when other domestic mitigations are more expensive. In that sense, Article 6.4 would probably trigger high-quality credits to be used for compliance. On the other hand, some compared VCM to the “wild west”. Here, demand in VCM will decide if the quality of the credits is a criterion of purchase. Another issue VCM will have to face is the pricing of credits, which is currently very low compared to the compliance markets. A convergence of VCM and compliance markets may happen in the long run, although many elements are to be clarified.
The glass is more than half-full
In conclusion, a key takeaway from the debate was that progress has been made, but we still need to learn, experiment, and implement the new rules. The glass is more than half-full, but we still need to figure out what is inside and we should accompany the evolution and not lower the guard.