New Paris Agreement Rules Will Enable
the Growth of International Carbon Markets

by Brian Chang

Although the conclusion of the recent COP26 climate change summit in Glasgow was marred by the last-minute watering-down of text relating to the use of coal, this should not overshadow the significant accomplishments that were achieved, including the long-awaited agreement over the long-debated “Article 6” rules in the “Paris Rulebook”. This agreement will enable the growth of international markets for carbon emission reduction credits, which will unlock billions of dollars in investment on emission reductions projects around the world.

Another achievement at COP26 was the inclusion of promises in the “Glasgow Climate Pact” that maintain the viability of the goals agreed in the 2015 Paris Agreement, of limiting global temperature increases “to well below 2°C and pursuing efforts to limit the temperature increase to 1.5°C above pre-industrial levels”. States agreed in Glasgow to “establish a work programme to urgently scale up mitigation ambition and implementation in this critical decade”, in recognition of the urgent need to collectively reduce emissions between now and 2030.

The Glasgow Climate Pact also “requests” States to “revisit and strengthen” the 2030 targets in their national climate pledges (“NDCs” or “nationally determined contributions” in climate change parlance) by the end of 2022. States are obligated to submit a revised NDC every five years, and many had just submitted a revised set of NDCs between 2020 and 2021, but credible estimates found that these commitments fall short and would lead to a best-estimate of around 2.6°C to 2.7°C warming by 2100. The world now has another chance, over the next year, to make collective commitments that will limit global temperature increases to the goals agreed in Paris.^[1]

While the Paris Agreement is principally focused on getting States to reduce their own carbon emissions, it recognises that market-based mechanisms for trading emissions reductions may help incentivise deeper overall reductions in carbon emissions than might be otherwise possible. Previous examples of market-based mechanisms include the Clean Development Mechanism (CDM) established under the 1997 Kyoto Protocol, and the EU’s Emission Trading Scheme (EU ETS), although they have faced significant challenges around the pricing and quality of emissions reduction units, including questions about the “additionality” of carbon offsets. Countries agreed to establish two market-based mechanisms of sharing carbon emissions reductions between States under Article 6 of the Paris Agreement. These include:

Article 6.2 – Transfers of carbon emissions reductions units between States (“internationally transferred mitigation outcomes” or “ITMOs”). ITMOs can take many forms, such as the Tuki Wasi program, in which Switzerland invests in reducing emissions in Peru by distributing efficient cooking appliances with an agreement to enable commercial transfers of the resulting carbon emissions reductions units from Peru to Switzerland’s NDC, and the Canada-Chile partnership to reduce emissions in Chile’s waste management sector. An emerging form of ITMOs, which may become the most commercially significant, will link regional, national and sub-national Emissions Trading Schemes (ETS), such as the linkages between the EU ETS and Swiss ETS and between the California ETS and Quebec ETS.

Article 6.4 – Establishes a new international carbon market that will replace the CDM, which revolve around carbon emissions reduction projects developed by both “public and private entities”, and which will be supervised by a new UN Supervisory Body.

However, the detailed rules on how these two market-based mechanisms would operate were not set out in the Paris Agreement, meaning that there was no operational way for States to count carbon emissions reductions from other States towards their own NDCs.

Over the past five years, States have struggled to reach agreement on the rules to operationalise Article 6, including during the COP24 climate change summit at Katowice which resulted in an incomplete “Paris Rulebook”. Key points of disagreement included: how to structure the carbon market so that it resulted in “additional” and overall carbon emissions reduction; whether a carbon emissions reduction unit could be “double counted” by both the buyer and seller towards both of their NDCs; whether and how many emissions reduction units from the previous CDM system could be utilised within the new system; and what percentage of the “share of proceeds” resulting from Article 6 transfers should be “taxed” to support adaptation in developing countries.

While the decisions on Article 6.2 and Article 6.4 reached in Glasgow are too detailed to be fully elaborated in this brief blog post, and more technical work remains to be done to operationalise them, several points can be made at this stage.

Firstly, although many States have now established or are in the process of establishing voluntary carbon markets or national/regional emissions trading systems, only emissions reductions units transferred under Article 6.2 or Article 6.4 can be counted towards other States’ NDCs. While States may set their own standards for their domestic carbon markets, the Article 6.2 and Article 6.4 rules will govern carbon emissions reductions units that are traded between countries to help the other country meet its NDC.

Secondly, a new international carbon market will emerge under Article 6.4, under the supervision of a new UN Supervisory Body, which is principally concerned with the transfer of emissions reductions units between countries to meet NDCs. Businesses will be able to participate by working together with countries to participate in activities that reduce emissions (similar to the CDM projects under the Kyoto Protocol). Such activities will hopefully increase the overall emissions reductions that is necessary to achieve the global goals, although they will need to be carefully monitored to ensure that they produce high quality, “additional” emission reductions. 

Thirdly, and very importantly, the country hosting an emissions reduction project (“host Party”) under Article 6.4 must decide if the reductions will be counted towards its own NDC or transferred elsewhere, and must make a “corresponding adjustment” (to avoid the problem of “double-counting”). Article 6.2 already included language prohibiting “double-counting” but the new Article 6.2 decision provides guidance on how “corresponding adjustments” should be applied and reported.

Fourthly, the carryover of carbon credits from the CDM to the new system is permitted under certain conditions, including that only CDM credits from projects or programs registered after 1 January 2013 can be carried over, and their use is restricted to the first NDCs. Estimates differ over the exact amount of credits that have been carried over, from 120 MtCO2e (million tonnes of CO2 equivalents) to 320 MtCO2e, but this is still far less than the 4,000 MtCO2e that might have flooded the new system if there were no restrictions.^[2]

Fifthly, negotiators agreed that a 5% “share of proceeds” resulting from Article 6.4 transfers will be transferred to the UN’s Adaptation Fund for developing countries. No levy will be imposed on Article 6.2 transfers although voluntary contributions for adaption purposes are encouraged.

Sixth and finally, in order to ensure that the new Article 6.4 market will achieve real reductions in carbon emissions, rather than simply offsetting CO2 released in one country with savings elsewhere, at least 2% of all emissions reduction units generated under Article 6.4 will be cancelled. This means that the new Article 6.4 market will create an overall mitigation (or reduction) of global emissions.

To conclude, the long-awaited agreement over the carbon market rules for the Paris rulebook will finally result in the establishment of a new international carbon market, although much work remains to be done to ensure its successful implementation. Negotiators, regulators, climate professionals and public interest organisations will need to scrutinise the output of the new UN Supervisory Body established under the Article 6.4 rules, and the projects and methodologies proposed by States under Articles 6.2 and 6.4, with a view towards ensuring that the carbon markets result in “additional” and overall carbon emissions reduction.

^[1] Carbon Brief estimates that, to limit global warming to 2°C, further pledges are needed to reduce carbon emissions by 9 to 12.5 GtCO2e (gigatonnes of carbon dioxide equivalents) between today and 2030. To limit global warming to 1.5°C, the additional pledges will need to rise to 24.5 to 27.1 GtCO2e. See final chart on Zeke Hausfather and Piers Forster, “Analysis: Do COP26 promises keep global warming below 2C?” (Carbon Brief, 10 November 2021)

^[2] Countries and companies that are seeking to purchase carbon credits to offset their carbon emissions should be aware that carbon credits may be of varying quality, and may wish to avoid CDM credits in favour of other “high-quality” credits with clearer “additionality” and “permanence”.