Despite of the current developments in the carbon markets and its tremendous growth during the last decades, the total amount of carbon credits issued only covers around a 16% of the total CO2 emissions generated.
Therefore, still 84% of these emissions are not covered by any carbon market and thus not compensated.
The Compliance Carbon Market with 31 schemes as of 2020, represents an 11% of the overall emissions, while the Voluntary Carbon Market only covers a 0.2%.
In that context, the size of the Voluntary Carbon Market compared to the Compliance Carbon Market, is only a 2% .
This is a modest start for the carbon markets, but the growing forecasts bring plenty of opportunities to these markets in the upcoming years. In that context, the entry into force of new regulations in regions that currently are not covered by any climate policy is expected to grow.
Some of the most recent developments of the carbon markets are:
- The adoption of the Carbon Offsetting and Reduction Scheme for International Aviation (CORSIA)
- The development of the Article 6 of Paris Agreement
Data based on retirement volume in 2020 across Verra, Gold Standard, ACR and CAR.
Source: World Global Carbon Project: State of the Voluntary Carbon Market 2019: World Bank State and Trends of Carbon Pricing 2021: BCG
As part of the strategy to achieve carbon neutrality, the International Civil Aviation Organization (ICAO) adopted in 2016 the Carbon Offsetting and Reduction Scheme for International Aviation, known as CORSIA.
CORSIA is the first global compliance scheme adopted by a specific sector and since 2019 it has applied to international aviation by enforcing airlines to report the CO2 emissions per airline on a yearly basis. The aviation sector committed to reach net zero emissions by 2050, and to reach this ambitious goal the offsetting requirements started in 2021.
The implementation of CORSIA will be done in three phases:
•Pilot phase (2021-2023)
•First phase (2024-2026)
•Second phase (2027-2035), where participation will be mandatory.
From January 2023, 115 countries are participating in CORSIA, and more have announced their intention to join from 2024.
This initiative, however, will not interfere with any effort on the implementation of new technologies able to increase the use of more efficient sustainable fuels while reducing GHG emissions.
Article 6 of the Paris Agreement
This article is a key part of the treaty and outlines the principles and mechanisms to pursue international cooperation to address climate change.
This article, which consists of 9 paragraphs, allows suitable financial approaches to support developing countries to meet the targets set out in their NDCs (Nationally Determined Contributions). In essence, as public funds are insufficient to reach these goals, the private sector will need to finance the implementation of an important part of the emission reduction projects.
Within Article 6, paragraphs 6.2 and 6.4 are particularly significant. These sections provide the framework to allow voluntary cooperation between countries to achieve their climate targets. This means that authorized emission reductions could be transferred to help other Parties to meet their goals, which may seem simple in theory, but in practice avoiding double counting will be crucial to maintain integrity.
Additionally, paragraph 6.8 promotes non-market approaches (NMAs), encouraging financial, technology transfer and capacity building cooperation between the Parties to address mitigation and adaptation.
In essence, Article 6 of the Paris Agreement provides the foundation of the future carbon markets, solving some challenges such as double counting and enhancing the robustness of the market.
Article 6.2 focuses on voluntary cooperation through a market mechanism between countries by enabling them to voluntarily trade with other Parties emission reductions and removals through bilateral agreements.
The transfer of Emission Reduction Outcomes (EROs), generated by their domestic actions to other countries, is done through a system of Internationally Transferred Mitigation Outcomes (ITMOs).
The aim is to increase global ambition and efficiency by allowing countries with higher mitigation potential to assist the ones with a greater need for emission reductions. Nevertheless, Article 6.2 is still under negotiation, therefore the detailed rules and procedures for its implementing are still not defined.
Despite that, some countries are already establishing their bilateral treaties, such as for example:
- Switzerland, who has already signed agreements or is in conversations with Ghana, Ethiopia, Malawi, Peru and Thailand.
- Singapore, who has already signed agreements or is in conversations with Colombia, Ghana, Peru, Vietnam and Thailand.
- Sweden, who has agreements with Ghana, Ethiopia and Nepal.
- South Korea, who has signed cooperation agreements with Vietnam
- Japan, who has already signed agreements or is in conversations with Bangladesh, India, Indonesia, Kenya and Vietnam.
The goal of Article 6.4 is to establish a global carbon trading mechanism between the Parties of Paris Agreement under the supervision of a United Nations organism. This mechanism referred to as the “Article 6.4 Supervisory Body” (6.4SB) is expected to be similar to the Clean Development Mechanism of Kyoto Protocol .
Projects must be approved by the Supervisory Body and the country of implementation before they can issue UN-recognized credits, known as A6.4ERs, which could be purchased by countries, organizations and individuals. The first credits under the scheme are to be expected in the following of years.
The detailed requirements and procedure for implementing Article 6.4 are also still under negotiation as Article 6.2.
Since the adoption of the Paris Agreement, negotiations have taken place at various UN climate conferences to finalize the guidelines for implementing Article 6.2 and 6.4 and setting up their operational rules while ensuring environmental integrity, transparency, and equitable outcomes.
Parties are seeking to address these challenges and create a robust framework for international cooperation under Article 6.2 and 6.4. While the countries work towards the implementation of these mechanisms, clear guidelines and strong governance structures are required to ensure effective and equitable collaboration in meeting climate goals.
The Article 6 of the Paris Agreement has the potential to provide opportunities only possible through cooperation while reducing global emissions and creating economic efficiency. However, maintaining integrity, robustness and credibility among the process is crucial and for this reason Corresponding Adjustments need to be developed.
Corresponding Adjustments (CAs) are an accounting tool to avoid double-counting in carbon trading when transferred and sold internationally and therefore the integrity of emission accounting is maintained.
Making a corresponding adjustment means that when a carbon credit is transferred across borders to be traded, the Party (country A) where the credit was generated renounce its right to use that emission reduction towards the National Determined Contribution (NDC), this process is known as authorization. Thus, this mitigation must be uncounted by the Party (country A) that agreed to the transfer.
From the moment of the authorization and the corresponding adjustment, there can be some delay which presents risks for the buyer (country B) who will depend on the government from the originating Party (country A) to finalize this procedure.
Corresponding Adjustments involve several challenges, that need to be addressed in order to alleviate these risks and to improve the administrative efforts for the buyers, producers and traders of carbon credits:
- The complexity of establishing robust accounting methodologies
- Ensuring transparency and accuracy in reporting
- Extend CAs requirements beyond Compliance Carbon Markets to Voluntary Carbon Markets
- Balancing the environmental integrity and facilitation of international cooperation in achieving climate goals