As the world turns its gaze towards Dubai, it is clear that universally adopted climate action is needed for us to achieve the global ambition of limiting global warming to 1.5°C above pre-industrial levels and reaching net-zero carbon emissions by 2050. An important mechanism that will allow nations to achieve this is the successful development and implementation of carbon credit markets. These ultimately need to be well-functioning and wide-reaching to effectively reduce carbon emissions. Despite best intentions, the strides taken under the Paris Agreement[1] to encourage country-to-country carbon trading haven’t had the impact we hoped to see. COP28 however presents an eleventh-hour opportunity to turn the tide.
Carbon trading works by allowing one party which has obtained carbon credits through activities that reduce or remove greenhouse gases (GHGs) from the atmosphere, to sell its carbon credits to another party who can use those carbon credits to offset its own GHG emissions. At country-level, purchased carbon credits may be used to count towards a country's Nationally Determined Contributions (NDCs) under the Paris Agreement.[2]
Article 6 of the Paris Agreement establishes two key mechanisms of carbon trading.
Article 6.2[3] allows countries to voluntarily trade GHG emission reductions (or “mitigation outcomes”) across countries. The carbon credits obtained from emission reductions and removals projects are known as Internationally Transferred Mitigation Outcomes (ITMOs) and can be traded through inter-governmental bilateral or multilateral agreements (known as "cooperative approaches"). The conclusion of the cooperative approach between Ghana and Switzerland at COP27 is an important example of an African success story in this regard.
Article 6.4[4], in turn, entitles project developers to trade carbon credits (or "A6.4ERs") which are generated through specific GHG mitigation projects. The ability to trade the credits is subject to the host country's consent. At this juncture, trading under Article 6.4 remains hypothetical pending the creation of a centralised framework for the issuance of A6.4ERs and appointment of the UNFCCC's supervisory body[5] by the COP. Whether the framework gets off the ground will be one of the key areas to watch at COP28. Once the framework is fully established, the issued carbon credits could be traded between public and private bodies under the supervision of and in compliance with the Article 6.4 Rules[6]. The Article 6.4 text also states that a “share of the proceeds” shall “assist developing country parties that are particularly vulnerable to the adverse effects of climate change to meet the costs of adaptation”. The aim here is for climate finance through carbon trading to be funnelled from richer nations which are generally larger emitters of GHGs, to developing countries that tend to be more vulnerable to climate hazards.
Article 6 provides important mechanisms for African countries to convert their natural resources into real returns to support sustainable economic growth. The provision does so by incentivising climate action globally and reducing the global costs of meeting climate goals by billions of dollars. According to a recent IETA financial model on carbon trading, in a global Article 6 carbon market where all NDCs are implemented cooperatively, by 2030 carbon trading transactions could surpass a value of US$100 billion every year.[7] Other proponents of Article 6 (such as the Environmental Defense Fund) have also suggested that the cost savings from carbon trading could “lower political barriers to more ambitious goal-setting” and further aid global climate action goals.[8]
The reality however is that in the absence of a minimum set of requirements to regulate the trade in carbon credits under Article 6, the potential exists for these mechanisms to be implemented inconsistently by the parties to the Paris Agreement. If so, the parties' actions could prevent the achievement of the Paris Agreements' ultimate objective: to reduce global GHG emissions. For instance, inconsistent environmental integrity requirements for the ITMOs being traded under Article 6.2 is an issue. At this juncture, the methodologies used to issue carbon credits traded under Article 6.2 are not subject to a minimum set of universal requirements nor do they need to go through UNFCCC approval and the related processes do not necessarily involve bodies accredited by the UNFCCC. The relevant Article 6.2 cooperation agreements would usually set out the minimum criteria that ITMOs transferred under the framework must satisfy. These criteria are however ultimately agreed between the parties. As one may expect, this subsequently creates a carbon market with ITMOs differing in quality which can still be used to count towards a country's NDCs. This also creates an environment for lowered ambitions as parties can actively seek agreements to trade low-quality ITMOs and yet the country can purport to have met the corresponding NDC.
Another issue is the risk of double counting of GHG reductions or removals by the parties involved in an Article 6.2 trade. The Article 6 Rulebook includes an accounting framework which is designed to avoid double-counting because the country hosting the relevant GHG reduction or removal project is required to deduct the transferred ITMOs from its own inventory following the sale. The country purchasing the ITMOs can then use it to count towards its carbon reductions inventory and NDCs[9]. However, there is a risk that such adjustment is not made by the relevant countries where the carbon transaction involves private entities; transfer of ITMOs to private sector entities occurs upon recognition by both countries that the ITMOs have been added to the receiving countries registry. This does not require the countries to carry out the corresponding adjustments of their inventories. Article 6 is unclear regarding how such a scenario would impact the value of the relevant ITMOs.
Given the scope of the set of rules which would establish the centralised framework under Article 6.4, the A6.4ERs regime could be a saving grace once it is operational. Several discussions tabled for COP28 should make this centralised carbon market more accessible. However, for now, it is unclear which GHG activities might be used to generate A6.4ERs in the first place. The Article 6 Rulebook agreed at COP26, provides that activities involving the removal or reduction of GHG emissions are expressly in scope of the mechanism but activities involving the avoidance of GHG emissions, whereby a project assumes how its existence could lead to future emissions being avoided, was left for further consideration.[10] In the same vein, Article 6.4 does not currently resolve the issue of inconsistency in the quality of carbon credits as there is still a lack of uniformity of the methodologies used to determine the carbon credits from different GHG activities and uncertainty as to how activities that result in temporary GHG emissions reductions will be dealt with.
It is important to acknowledge the technical complexity of establishing a single and fully integrated carbon market. The pit-falls in Article 6 must be acknowledged and the global community should expect them to feature as key topics for discussion during COP28. Whether Article 6 of the Paris Agreement can be used to impose more aggressive goals to reduce GHG emissions is yet to be seen, with enforceability as a known challenge for many international agreements. For now, a carbon trading mechanism based on clear minimum requirements for the environmental integrity of ITMOs and A6.4ERs is a good starting point and COP28 provides an opportunity for this to be established.
[2] Nationally Determined Contributions ("NDCs") are required pursuant to Article 4 of the Paris Agreement. Each country which is a party to the Paris Agreement must prepare, communicate and maintain successive NDCs, being the long-term mitigation and adaption measures to be implemented by that country in a bid to achieve domestic and international climate goals.
[3] Article 6.2 of the Paris Agreement.
[4] Article 6.4 Mechanism, United Nations Climate Change website.
[5] UN Framework Convention on Climate Change.
[6] Draft text; Matters relating to Article 6 of the Paris Agreement: Rules, modalities and procedures for the mechanism established by Article 6, paragraph 4, of the Paris Agreement.
[7] "Modeling the Economic Benefits of Article 6", IETA Report, page 8.
[8] "Power of markets to increase ambition", Environmental Defense Fund, page 1.
[9] "Article 6 Transaction Structures", World Bank et al., 21 April 2022, section 3.1.2, pages 6-7.
[10] UNFCCC, Decision 3/CMA.3, 2021, Rules, modalities and procedures for the mechanism established by Article 6, paragraph 4, of the Paris Agreement, paragraph 7(h).
Key contacts
Disclaimer
The articles published on this website, current at the dates of publication set out above, are for reference purposes only. They do not constitute legal advice and should not be relied upon as such. Specific legal advice about your specific circumstances should always be sought separately before taking any action.