How Carbon Markets Can (and Can’t) Grow With Article 6 on Ice

15 December 2019 | MADRID | Neither Franz Perrez nor Ricardo Salles were at the top of their game after a week of overnight negotiations at year-end climate negotiations here.

Perrez, who is Switzerland’s Ambassador for Climate Change, seemed a bit hyper, while Salles, who is Brazil’s Minister of Environment, seemed half asleep as Perrez unleashed a rhetorically subtle (but grammatically confusing) swipe at the Brazilian in the closing hours of year-end climate talks (COP25).

“We all know that if you (meaning either all climate negotiators or Brazil alone) had agreed here in Madrid on the last proposal that you (meaning Chilean Environment Minister Carolina Schmidt, in her capacity as President of COP25) presented, we would have created a robust source of funding for the Adaptation Fund,” said Perrez.

He made the comment just minutes after the Argentinian delegation had lamented the lack of funding for adaptation but hours after Salles, with help from the Australian delegation, had blocked agreement on how to create a rulebook for Article 6 of the Paris Climate Agreement. That’s the article governing international carbon markets, and a clear rulebook could have provided adaptation funding through transaction fees and other benefit-sharing arrangements. Instead, it remains the only article that doesn’t have clear procedures of implementation.

More than half of all Paris Agreement signatories included markets in their climate action plans (NDCs), and without clear guidance on markets, higher ambition cannot be defined.

Still, dozens of countries seem set to move forward on markets by building on those elements of the Article 6 rulebook that almost everyone agrees on, while the International Civil Aviation
Organization (ICAO) is moving ahead with its emission trading system for international passenger flights, set to begin phasing in at the end of 2020.

 “The Last Proposal You Presented”

The last proposal that Schmidt presented came shortly after 1am local time, following 12 straight hours of negotiations. Perrez and representatives from several other countries have vowed to move forward with the creation of bilateral and multilateral carbon markets under that text, even though further rulemaking was pushed back to the next meeting of the Subsidiary Body for Scientific and Technical Advice (SBSTA). That meeting will take place in June 2020, in Bonn, with final adoption happening at next December’s COP in Glasgow, Scotland, at the earliest.

Perrez said there was enough agreement on the rules for paragraph 6.2, which covers bilateral trading and accounting of emission reduction units, to move forward.

“We will seek to engage in bilateral activities under 6.2,” he said. “And, when doing so, we intend to apply the guidance and cooperative approaches as planted last night by the presidency.

Such cooperation could take the form of “Carbon Clubs,” which are clusters of countries trading among themselves much as countries operating under the General Agreement on Tariffs and Trade (GATT) already do. Support for carbon clubs seemed to be gaining support before the adoption of the Paris Climate Agreement in 2015, but the strength of the Agreement put that support on hold. After COP24 failed to generate a rulebook in Katowice, several negotiators told Ecosystem Marketplace they would revisit the use of carbon clubs if failure extended beyond COP25 in Madrid.

That failure has now arrived, and club proponent Nat Keohane, an environmental economist with the Environmental Defense Fund, says he’s getting indicators of interest from several participants.

“We are in the race of our lives to beat global warming, and the rules are changing,” he wrote in an e-mail to reporters. “A decade ago, the presumptive approach was a global governance structure under the auspices of the United Nations. Now, the challenges are more urgent and the landscape is more decentralized.”

The Current State of Article 6

Article 6 is broken into eight paragraphs, and rules for implementing three of those paragraphs went through several iterations over the past two weeks. Even before Schmidt’s intervention last night, there was widespread agreement on rules for paragraphs 6.2, which covers bilateral trading and accounting of emission reduction units, and 6.8, which covers non-market transfers.

The problem has always been rules around paragraph 6.4, which covers the creation of a centralized hub to replace the Kyoto Protocol’s Clean Development Mechanism (CDM). Brazil has been blocking efforts to restrict the use of old CDM units in the new mechanism, dubbed the “Sustainable Development Mechanism,” and also pushing for the right to count exported emission reductions towards its NDC, leading to a severely marked-up version until Schmidt forged a clean version this morning.

In the plenary, several ministers – including those from Egypt, Brazil, and the European Union – asked for the earlier, marked-up versions of the text to be passed on to negotiations in June so that all existing input could be considered.

(Note that, due to a glitch on the UNFCCC web site, these links are going to a Dropbox at press time. If they don’t work, you should be able to access the documents here.)

The San Jose Principles

On Saturday, 31 countries, known as the “Unconventional Group,” formally submitted the San Jose Principles for High Ambition and Integrity in International Carbon Markets to the COP. The principles had begun taking shape in September, at the Pre-COP San José, Costa Rica. Economically, the countries are a diverse bunch – ranging from industrial Germany to the island nation of Trinidad and Tobago – but they are all either highly threatened by climate change or highly progressive on meeting the challenge.

Switzerland falls into the latter category, and Perrez explicitly committed his country to the San Jose Principles in the closing plenary.

Who Loses Without 6.4?

Tragically, those countries that lose without clear rules around a Sustainable Development  Mechanism under paragraph 6.4 are the ones that need it the most: smaller countries without the scale or resources to develop their own trading infrastructure.

“I would say it would mean less access for a lot of countries because the carbon club concept is probably going to be taken forward by those that have been working in things like the Partnership for Market Readiness or that already have emission trading laws on the books or carbon taxes on the books and can accelerate and build on those,” said Dirk Forrister, CEO and president of the International Emissions Trading Association (IETA).

National programs like Colombia’s carbon tax will also continue, as will voluntary carbon markets, which appear to be headed for a record year in volume, according to Ecosystem Marketplace research.

International Passenger Flights

The biggest source of compliance demand on the horizon comes from ICAO’s Carbon Offsetting and Reduction Scheme for International Aviation (CORSIA), which is part of an international agreement to cap emissions from international passenger flights at 2020 levels, beginning in 2021.

CORSIA will allow airlines to meet their obligations by purchasing ICAO-recognized offsets, but it is not yet clear which offset types will be recognized under the program. A decision is expected in early 2020.

In the meantime, EasyJet is already offsetting emissions from all flights voluntarily, while Air France and British Airways are voluntarily offsetting domestic flights. The potential new demand from airlines is enormous, as passenger flights generated the equivalent of 900 metric tons of carbon dioxide in 2018 alone.

CORRECTION: This story initially identified Edinburgh as the location of COP 26.