The Evolving Role of Carbon Markets
CHALLENGES REDEFINING PROJECT DEVELOPMENT
The Paris Agreement created a new framework for climate change mitigation. It brings an approach where all countries are invited to propose non-binding “nationally determined contribution” (NDC) to reduce GHG emissions.
The implementation of this framework brings new challenges that project developers should be aware of as it requires a redesign of the Voluntary Carbon Market. These challenges include:
- The risk of double accounting between country level NDC and VCM offset claimants.
- Conflicting interests between generation of offset revenues and promoting country-level ambition.
- Demand for Enhancing Credibility: Environmental Integrity and Carbon Credit Quality
DISINCENTIVIZING CLIMATE ACTION: DOUBLE COUNTING
An important policy change brought by the Paris Agreement is to no longer differentiate countries committed to finance climate action from countries that were the recipient of projects to reduce or remove GHG emissions. In addition, the agreement allows all countries to determine their own level of commitment through non-binding “nationally determined contributions” (NDC).
As it is possible for both private and public stakeholders to exercise claims to emission reductions or removals, it is fundamental to balance the accounts through “corresponding adjustments” to avoid “double counting” or “…counting the same emission reduction more than once to achieve climate mitigation targets” (Scheneider et al. 2019).
In addition, by allowing countries to determine their own levels of ambition, the agreement exposes the limitations to the definition of “additionality” defined under the Kyoto Protocol. Thus, a revised definition shall clearly state that for a project to be “additional”:
“The activity is not required or likely to have been implemented due to national policies or legislation and would not have occurred in the absence of the incentives of the mechanism.” (NCI 2023)
CONFLICT BETWEEN OFFSETTING CLAIMS AND NDC
The Voluntary Carbon Market (VCM) generates finance via the issuances of carbon credits for offsetting claims. This has an unintended consequence under the Paris framework creating pitfalls in the supply and demand side of the market (NewClimate Institute 2023):
Demand-side ambition pitfall:
When the cost of offsetting through carbon credits is lower than the cost of abating carbon emissions, there is a risk of delaying action. Thus, “the costs of using carbon crediting mechanisms for offsetting or compliance purposes must be high enough” to encourage action instead of increasing the demand for offsetting claims. (NewClimate Institute 2023a, 2023b)
Supply-side ambition pitfall:
Countries could face the perverse incentive to limit their carbon reduction ambitions to receive revenue from carbon credit issuance. Thus, the usage of carbon credits should focus on areas that will not present conflicts to what countries could achieve on their own.
This Figure 3.1 shows scenarios where an emission reduction project interacts with country level climate action with diverse implications on Net Global GHG Impact.
Figure 3.1. Climate impact of different voluntary carbon market scenarios.
In short, generating revenue from the issuance of carbon credits should not dissuade countries from committing to ambitious targets that would in turn eliminate the “additionality” of the crediting mechanism.
To this end, the authors of the report suggest that voluntary markets should evolve into a new model where we no longer speak of issuing carbon credits for “offsetting claims” but to focus on “climate contributions”.
What is a climate contribution?
“Climate contributions reflect finance provided by an organization to support climate action beyond its own value chain, without claiming to offset, or neutralize, any actual emissions. They represent a financial commitment that is a complement – and in no way an alternative – to directly reducing one’s own climate footprint.” (NCI 2023, 14)
The authors of the report by the German Environmental Agency (2020) propose two pathways to redesign the VCM to work with the new requirements of the Paris Agreement. On one hand, implement the Non-NDC crediting model (very similar to the current model) and shift in the medium term to an NDC crediting model by which will allow to continue using credits for offsetting for a limited time.
On the other hand, the report proposes a Contribution claim model where credits are no longer use for offsetting claims and as such do not represent a conflict with meeting NDCs.
Figure 3.2. Viable voluntary market models within the Paris Agreement framework (Source: German Environmental Agency 2020)
A NEW DEFINITION OF ADDITIONALITY?
A change in the operating model to focus on “contribution claims” depends on updating the definition of additionality, where a “…project should be sufficiently ambitious that they avoid presenting any conflict with the host country’s own ambition” (NewClimate Institute 2023)
To this end, “additionality” should include a demonstration of project inaccessibility. For example, high marginal abatement costs can provide an indication of the relative inaccessibility of technologies and measures to the host country.
This inaccessibility is what is defined as a High Hanging Fruit. In this way, carbon credits used for offsetting claims give way to climate contributions without offsetting claims.
To better illustrate this concept, we use Figure 3.3 to show the high-hanging fruit projects area that depend on maturity stage of local technology development and moderately high to very high abatement costs.
Figure 3.3. (Source: NewClimate Institute 2023)
Furthermore, Figure 3.4. shows the possible sectors where these high hanging fruit projects could take place considering technological maturity.
Figure 3.4. (Source: NewClimate Institute 2023)
BEYOND VALUE CHAIN MITIGATION: CLIMATE CONTRIBUTIONS
Climate contributions without offsetting claims serve to finance action in areas/sectors with high uncertainty in the development of mitigating technologies. These areas would be outside of the possibilities of countries. Thus, it would avoid a conflict of interest between ambition and mitigation revenue as we explained earlier.
Moreover, “…Climate contributions reflect finance provided by an organisation to support climate action beyond its own value chain, without claiming to offset, or neutralise, any actual emissions…”. These contributions will serve to pay for unabated carbon budget or footprint of a company. The carbon fee could be calculated by multiplying the company’s company footprint (scopes 1, 2 & 3) by a unit cost for carbon emission between US $100 to $250 per metric ton of CO2e.
Figure 3.5 Recommendations for the climate contribution approach (Source: NewClimate Institute 2020).
WOULD THESE CHANGES OR REFOCUS IMPACT THE ROLE OF PROJECT DEVELOPERS?
In short, NO.
Climate contributions are a complement to climate reduction action, for which projects will still need to be carried out within an auditable framework to safeguard the integrity of its outcomes and impact. What could change is the product issued by the independent crediting mechanisms or standards.
Climate contributions should be spent on a range of activities that have the potential to yield significant progress in decarbonizing our economies, including emission reduction and removal projects, R&D of inaccessible technologies to sustain economic prosperity without fossil fuels, or advocacy for strong climate regulation.