EU can fund climate results abroad for more credible carbon credits: Report

A new study by the Potsdam Institute for Climate Impact Research (PIK) has proposed a novel mechanism that could help the European Union (EU) achieve part of its 2040 climate target through international cooperation at a cost of just €5 billion annually, while avoiding many of the pitfalls associated with traditional carbon credit markets.

Under the European Union's 2025 climate law, the bloc is required to cut greenhouse gas emissions by 90 per cent by 2040 compared with 1990 levels. Up to 5 percentage points of that reduction can come from climate action outside the EU through international carbon credits permitted under the Paris Agreement.

The study argues that instead of relying on conventional project-based carbon offsets, the EU should create performance-based "Jurisdictional Reward Funds" that would reward governments in developing and emerging economies for demonstrable improvements in climate action.

The proposal aims to address concerns that international carbon credits can encourage greenwashing or reward actions that would have happened regardless of external financing. Critics have long argued that countries may set weak climate targets initially to secure larger rewards later, while some emissions reduction projects lack genuine additionality.

"Our analysis shows that the international flexibility built into the EU's 2040 climate target should not simply be dismissed as a questionable substitute for political ambition at home," said Ottmar Edenhofer, director of PIK and Chair of the European Union climate advisory board. "Rather, climate protection beyond our borders acts as a stabilising mechanism. It ensures that ambitious climate policy in Brussels remains realistic in the future, regardless of what is decided in Beijing or Washington."

According to the study, all developing and emerging economies with a proven record of strengthening climate policies would be eligible for funding under the proposed framework. Countries would compete for a fixed pool of finance, with rewards linked to measurable performance against common benchmarks.

"The option of crediting climate protection efforts beyond one's own borders is an opportunity if it is designed correctly," said Lennart Stern, researcher at PIK and co-author of the study. "To avoid the perverse incentives of previous voluntary carbon markets, we propose a more efficient framework. Brussels would provide financing via so-called Jurisdictional Reward Funds as remuneration for efforts made by governments outside the EU."

One example cited in the study is forest conservation. Countries that reduce deforestation beyond a universally established benchmark could receive higher payments from the fund. The mechanism is designed to reward additional and above-average climate action rather than simply financing existing programmes.

The researchers estimate that achieving emissions reductions equivalent to 5 per cent of 1990 European Union emissions through the scheme would cost around €5 billion in 2040, or about €21 per tonne of carbon dioxide (CO2) avoided.

The study suggests the most cost-effective allocation of funding would direct 62 per cent toward coal phase-out efforts, 32 per cent toward reducing oil and gas production, and 6 per cent toward forest conservation.

Beyond lowering emissions globally, the researchers argue the mechanism could also help stabilise carbon prices within Europe. International carbon credits generated through the programme could be integrated into the European Union Emissions Trading System (ETS), which covers power generation and energy-intensive industries.

According to the analysis, gradually introducing international carbon credits into the ETS between 2036 and 2050 could lower carbon prices by an average of 40 to 45 per cent compared to a scenario without such credits. At the same time, incentives to move away from fossil fuels would remain strong because investors would expect carbon prices to increase globally as climate cooperation expands.

The study notes that substantial low-cost emissions reduction opportunities remain available in developing and emerging economies. However, if major economies such as China or the United States adopt similar reward-based mechanisms in the future, competition for these opportunities would increase, raising costs and requiring a larger share of the EU's climate target to be achieved domestically.

The researchers argue that such a scenario would ultimately strengthen global climate action while reducing Europe's exposure to climate policy risks, creating a more balanced and cooperative international approach to emissions reduction.