Markets need to be transformative, not just efficient
Finalising rules on carbon markets is a priority at the Conference of Parties 25 or CoP 25 (see the Centre for Science and Environment or CSE's primer here). Midway through the first of two weeks of negotiations, progress remains limited. New negotiating text emerged on December 4 on Article 6 (the ‘markets article’ in the Paris Agreement). A number of highly technical issues still remain to be resolved.
The Paris rulebook needs to (indirectly) regulate bilateral/mini-multilateral markets
Markets under the Paris Agreement come in two types. Article 6.2 sets up rules for credits traded on bilateral or mini-multilateral markets (such as the European Union Emission Trading System) if such credits are being counted towards a country’s nationally determined contribution (NDC).
Negotiations on Article 6.2 are divided over whether bilateral / mini-multilateral markets need a common set of accounting rules, or whether countries using credits from such markets can pick from a ‘menu’ of accounting standards.
The important thing to note here is that the Paris Agreement cannot prevent countries from forming their own bilateral or mini-multilateral markets. The trigger that draws the Agreement’s attention is if a country wants to count a credit traded (on whatever type of market) towards its NDCs.
Even if it does not directly regulate the market, the Paris markets rulebook should do everything possible to protect the sanctity of NDCs, which are the heart of the Agreement. So, any credit being counted toward an NDC should follow a common, rigorous accounting standard.
Allowing countries to choose their own accounting systems will make keeping track of ambition extremely difficult. This will undermine the new round of NDCs, which are due in 2020 (see CSE’s primer on NDCs here).
Overall Mitigation of Global Emissions may be easier done than said
Article 6.4 sets up the Sustainable Development Mechanism (SDM), a centralised, global market designed as the successor to the Clean Development Mechanism (CDM) in the Kyoto Protocol. It is clear that the SDM will bind countries to a single set of rules, but the governing structure of that mechanism still needs to be fleshed out.
Besides, the SDM under Article 6.4 is required to deliver an “overall mitigation of global emissions” (OMGE). This is a response to a key flaw of the CDM under the Kyoto Protocol — that it might have increased rather than decreased the globe’s emissions. However, OMGE itself has not been defined. There is continuing disagreement over whether a definition is needed.
More encouragingly, despite the definition confusion, the recently released texts contain reasonably strong language on a mechanism targeted at achieving OMGE, known as ‘voluntary cancellation’.
Under this mechanism, a certain percentage of created credits are cancelled (i.e not counted towards any country’s NDC). This aims to ensure that the amount of credits does not exceed the cumulative ambition of emission reduction targets.
Carrying over credits from Kyoto to Paris remains a sticking point
Across Articles 6.2 and 6.4, strong disagreement continues about whether credits created under the Kyoto Protocol can carry over to the Paris Agreement markets. There are around 4 billion such credits, representing 4 gigatonnes of carbon dioxide equivalent. Allowing these to count toward national targets under the Paris Agreement will wipe out any mitigation ambition included in these targets.
This ‘hot air’ problem was the most significant sticking point at Katowice last year. Some negotiators suggested not addressing the issue at all in this year’s text, others emphasised the need to address the issue to ensure an orderly transition between the mechanisms.
Some developed country negotiators in Madrid on December 5 expressed seriousness about including strong text against carryover, but the biggest obstruction is Brazil, which has a lot of credits to sell.
However, there is confusion on what happens to credits created based on activities or sectors which are not listed in a country’s NDC. A common expression used to describe carbon markets is ‘cap-and-trade’. If a country does not include a sector — transportation, for example — in its NDC, what is the ‘cap’ under which it can generate tradable credits?
Markets need to move from ‘efficient’ to transformative
Negotiators were divided on whether to ask technical bodies to create new methodologies to measure business-as-usual baselines, or whether methodologies under the CDM under the Kyoto Protocol (which cost a lot to developed) could be tweaked or improved on.
The fundamental flaw with the CDM, however, is that it was aimed at finding the cheapest possible mitigation, with terrible results. The methodologies improved over time, but could not ever overcome that barrier. Markets under Article 6 need to be oriented towards transformation, which requires a very different methodological approach to defining baselines.
They should be used for the sole purpose of incentivising technologies or activities which are technically proven to significantly reduce emissions, but which are currently far from being economically feasible. Pinning down language which focuses markets on this task is key.
A boost to the Adaptation Fund?
The Adaptation Fund was set up under the Kyoto Protocol to finance projects and programmes in developing countries to adapt to the harmful effects of climate change. The finance was raised by levying a 2 per cent “share of proceeds” on the value of credits traded on the international carbon market under the Protocol — known as the ‘Clean Development Mechanism’.
At Madrid, there is an emerging consensus around allocating 5 per cent of the value of credits traded on the SDM under Article 6.4 to the Adaptation Fund. The potentially significant increase of funds that will become available for adaptation through this route is causing its own problems in Madrid, as we examine here.
While markets are consuming the bulk of negotiating time at CoP25, negotiators are still worried that it might not be enough. The two weeks of a CoP are generally divided into an initial ‘technical’ week, which produces a basic text with some options, and a second ‘political’ week, when the tough trade-offs and compromises are expected to be made.
The extremely technical nature of markets negotiations has confounded this dynamic — technical negotiators are wary of leaving tough choices to political representatives who have little expertise in this area. Unless there is a breakthrough in the next few hours, though, the technical wrangling is likely to continue into next week.
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