Category: Article 6

What to make of Article 6 at COP25?

dchone December 18, 2019

I spent a week at COP25 in Madrid, with great hope that the negotiators would land the Article 6 text and complete the so-called Paris ‘rule book’. Unfortunately it wasn’t to be the case and the longest COP to date was closed with little to show for the immense amount of effort that was put into it, from the Chilean Presidency, the Spanish hosts and the thousands of attendees. But the COP didn’t end with nothing, in that we do have near completed text for Article 6, albeit entirely bracketed, reflecting the lack of final agreement. Brackets are normally used to surround individual words or short passages of text that remain contentious, but in this case they surrounded the Article 6 guidance in its entirety.

In a world where there is increasing pressure (and need) to get to an effective state of zero emissions, the ability to use the market to deliver such outcomes by “trading” emission reductions and sinks between countries and sectors, becomes critical. I illustrated this in a recent post which stepped through the transition illustrated below.

Despite a goal of zero, 300 units of CO2 emissions still remain in hard to abate sectors.

Article 6 delivers an overall reduction, with a net-zero emissions outcome.

The final Madrid text reflects a great deal of effort by the Parties, albeit many of the same issues resurfaced during the discussions and highlighted the differing perspectives, and understanding, of Parties on the role and application of Article 6. This will require all Parties to work hard to bridge differences to see an agreement in 2020.

The entirely bracketed Article 6.2 text looks very good in that it covers the key requirements for a transfer. The definition of the internationally transferred mitigation outcome (ITMO) is sound and importantly includes removals, a clear requirement over the longer term and a necessity for net-zero emissions (see above illustration). The guidance on corresponding adjustments adopts a carbon budget approach to the methodology, which provides the highest standard for environmental integrity of the transfer. The text also provides for Article 6.4 emissions reduction units (6.4ERs) to be transferred via this process.

The 6.2 guidance asks participating Parties to cancel some ITMOs to ensure overall mitigation in global emissions, but importantly this is not a requirement for use of the process. In some instances it may be practical for participating Parties to agree on such a step, but in others it is unlikely to happen. For example, the net flow of allowances between two linked emission trading systems (e.g. Switzerland and the EU) will be an ITMO relative to the respective Nationally Determined Contributions (NDC) within which the trading systems sit, but deciding which allowances to remove from the system when hundreds or even thousands of private entities might be involved is both impractical and self-defeating for the link, in that if there is a penalty for trading with a cross-border entity against a domestic entity, then domestic trades will prevail and the synergy of the link will be lost.

Despite the big brackets and the meeting of the Parties to the Paris Agreement (CMA) only noting the guidance on Article 6, it is very likely that the 6.2 text will be used by Parties as it currently stands. Switzerland and the EU may well be the first Parties to do so as they link their respective trading systems from 1.1.2020. Use of the current 6.2 text may also help legitimize it in the case of the CMA never actually agreeing it.

While the 6.2 guidance was largely (but not completely) without contentious points within the bracketed text, this was not the case for 6.4, where many of the issues going into the COP remained unresolved as it finally closed on Sunday, resulting in the big brackets around everything – remember, in UN parlance, nothing is agreed until everything is agreed. Unlike 6.2 transfers where Parties can simply start using the text on a bilateral basis, this cannot be the case for 6.4 because it is a centrally administered mechanism with a supervisory body, which cannot exist until all Parties agree to the text. So while there is text that looks to be complete, we are still some distance away from it being agreed and the mechanism beginning to function. This means that some countries looking for foreign direct investment through the mechanism as a means of achieving mitigation will have to wait. It may also mean that they pursue other energy infrastructure projects which could lead to lock-in of a higher emitting system. Nobody wins through such a delay.

Some of the points that remain to be agreed in 6.4 are also issues that shouldn’t really be open for debate; not in a world looking for a successful implementation of the Paris Agreement.

The issue of actions taking place outside the bounds of the NDC is one, when in reality the NDCs need to quickly shift to cover all emitting activities. This should be the first requirement for the agreement that was reached in Madrid that all NDCs are resubmitted next year. As such, there would be no actions taking place outside the bounds of the NDC, which makes the provision entirely superfluous.
A second issue is related to the transition of remaining units (CERs and AAUs) from the mechanisms of the Kyoto Protocol, with the request from some Parties that they can be utilized and transferred under the Paris mechanism. For existing projects with future issuance, this shouldn’t be an issue in that any use of the units will be balanced by the necessary corresponding adjustments required under the transfer process of 6.2, although some Parties argued that these projects are outside the scope of current NDCs, to the extent that corresponding adjustments wouldn’t be required. But for vintage units there is a clear reason not to allow future use which sits in the IPCC Special Report on 1.5°C. That report established the current level of warming and reset the carbon budgets for various levels of future warming, with a 1.1.2018 baseline. For example, limiting warming to 1.5°C with a 67% chance has a carbon budget of 420 Gt from 1.1.2018. The Paris Agreement is increasingly being formulated around the finding of the report. As such, events prior to that date are now irrelevant, including any units that may have been created.

There was still no agreement on a share of proceeds from the use of Article 6.4 or on how an overall mitigation in global emissions is determined, key issues for some Parties that reflects the importance of demonstrating the potential of trade to deliver emissions reductions. A simple analysis of the use of Article 6 shows that it alone delivers mitigation that wouldn’t otherwise occur, as I illustrated in the recent post referenced above. Unfortunately, some negotiators didn’t see this point and the call for surrender of units continued, with a minimum haircut of 2% appearing in the bracketed text. Penalties such as this will do nothing to promote the use of the mechanism, but only deter investment.

So there we have it, a fortnight of negotiation that very nearly resulted in a good Article 6 ‘rule-book’. But it didn’t and that is unfortunate for all concerned, but particularly for the successful implementation of the Paris Agreement. Let’s hope that Parties can quickly reconvene around the final Madrid text and bring it to a conclusion, perhaps even before COP26 in Glasgow, in that the formulation of mid-century development strategies and more ambitious NDCs for that COP is in part dependent on the availability of Article 6 transfers.

Article 6: A job to do at COP25

dchone November 29, 2019

As the Parties and representatives of the many UNFCCC observer organisations gather in Madrid, there is talk of increased mitigation ambition and the need to step up the global response to the many changes now being seen in the climate system. With the release of the Gap Report, the UN Environment Programme (UNEP) noted that greenhouse gas emissions in 2018, also accounting for deforestation, rose to more than 55 gigatonnes, and have risen on average by 1.5% a year for the past decade.

Source: UNEP Gap Report 2019

UNEP stated that global emissions must fall by 7.6% every year from now until 2030 to stay within the 1.5°C ceiling on temperature rises that scientists say is necessary to avoid disastrous consequences.

While this is an important statement, should another clarion call be the overriding theme of COP25?

Perhaps even more important than the call to act is the creation of the economic conditions, mechanisms and processes that will facilitate the shift. The Paris Agreement itself was a critical step in that journey and we have seen in just a few years that the global focus has shifted from talk of percentage reductions to an emphasis on net-zero emissions. This has changed the landscape and given a clear long-run signal to businesses and governments, with the result that numerous countries are now either pondering a 2050 goal of net-zero emissions or have actually established such a goal. Similarly, many businesses and sectors are now thinking along such lines and some have a focus on establishing zero emission business models to grow alongside the (diminishing) legacy systems they have in place.

But the landscape required for global action is far from complete and this is what COP25 can help deliver. Article 6 of the Paris Agreement was left out of the otherwise complete ‘rule-book’ at COP24 in Poland, with the Parties unable to agree on the architecture of cooperative approaches. Superficially this may seem to be a minor issue and certainly not something that would stand in the way of progress, but cooperative approaches should be viewed in the context of global trade which is a key enabler of the global economy.

Trade underpins economic activity and offers society the flexibility to provide the wide range of goods and services that we all benefit from – not everyone can economically produce everything themselves. For example, trade in commodities provides materials for manufacturing and construction that may be unavailable domestically. Trade is often the underpinning reason for foreign direct investment. It encourages the business sector to engage in projects and activities outside their traditional base with a view to bringing goods and services into that base.

This is also true for managing emissions – not all countries can reduce emissions at the same rate and it is certainly not the case that every country can be at zero emissions when needed, so we could use trade to collectively get there through Article 6.

Article 6 is essential for the journey to and destination of net-zero emissions. Recently published research from IETA and the University of Maryland found that cooperation through Article 6 has the potential to reduce the total cost of implementing NDCs significantly, in the order of $320 billion/year in 2030, or alternatively facilitate removal of more emissions, in the order of 9 GtCO2/year in 2030, at no additional cost if those cost savings are reinvested into additional mitigation.

By channeling investment towards zero emission energy systems and expanding the use of natural and artificial sinks, Article 6 can help deliver of the goals of the Paris Agreement. For the most part, this would be pursued through projects enabled by the private sector, including their use of the provisions within Article 6 and the issuance of tradable units by host governments.

Article 6 offers the opportunity to scale the millions of tons of emission reductions that the Clean Development Mechanism (CDM) of the Kyoto Protocol delivered from a multitude of small projects to gigaton reductions from large-impact programmes featured in economy-wide NDCs. To do this, Article 6 must be fit for that purpose and not anchored to the thinking of two decades ago. We learned much from past mechanisms, but they were never designed for the long haul. Carbon would potentially trade at the scale of the commodities that underpin it, such as oil, coal and iron ore. Today, the global crude oil market is around $2 trillion per year (based on producer to end-user sale at $50-$60 per barrel); a global carbon sink market of around $1 trillion per year could be envisaged as underpinning the journey to net-zero emissions in the 2050s (Sky 1.5 Scenario with sinks trading at a notional value of $50 per ton of CO₂).

Article 6 establishes a reliable framework within which carbon based trade can be efficiently and expeditiously executed between various national emission markets and projects while ensuring environmental integrity at a global level. This is analogous to the way globally established rules and institutions allow currency markets to function. Article 6 will give confidence to investors in clean energy and emissions mitigation projects and ensures that all countries access the market through a common framework. This in turn delivers cost efficiency and ultimately enhanced mitigation.

COP25 in Madrid must deliver a simple but rigorous rule book for Article 6, which is based on transparent numerical accounting, recognizes both natural and industrial sinks and supports and encourages large scale transactions.

An Article 6 Case Study: Brazil

dchone November 14, 2019

In a recent post I illustrated how Article 6 of the Paris Agreement might work in practice, using a small set of archetype countries as shown below. While there are many ‘Country A’ examples, it is more difficult to think about what sort of economies come close to ‘Country B’. Brazil could well be such an example.

Brazil is rich in renewable energy, it has a mature biofuel industry that could doubtless move towards new biofuel processes as they emerge and it certainly has vast potential for developing carbon dioxide sinks through reforestation and afforestation in the Amazon area of the country. Although it isn’t at zero emissions as illustrated in the diagram, the major current use of fossil fuels is oil for transport, which could diminish significantly through electrification, leaving a near zero emissions economy. In Brazil, industry makes considerable use of biomass for energy.

One would therefore imagine that Brazil could make considerable use of Article 6 of the Paris Agreement and generate real benefit for the domestic economy. But just how significant might this be for Brazil?

A recent analysis by the University of Maryland, underwritten by the International Emissions Trading Association (IETA) and the Carbon Pricing Leadership Coalition (CPLC), models the impact of Article 6 on the global implementation of the Paris Agreement. The study finds that the potential benefits through cooperation under Article 6 in achieving the Nationally Determined Contributions (NDC) are considerable and all parties could benefit. Potential cost reductions over independent implementation of countries’ NDCs total about $250 billion per year in 2030, although this number rises to $320 billion when Article 6 includes trade in carbon units related to land use change. This would appear as the sale of carbon removal units (or sinks) as a result of forestry and other land use change activities. Cost reductions from cooperative implementation are achieved through improved global economic efficiency and effective sourcing of the lowest cost mitigation opportunities. It should also be noted that the cost and benefit number produced are model outputs, which should be obtainable under perfect economic conditions akin to the model parameters, but otherwise are representative of the direction and scale of change that will be seen for the scenarios they represent.

2030 Potential Article 6 Reduction in Cost (Billions 2015 USD/year)
	Reduction in Cost	Increased Ambition
Fossil Fuels Only	$250 billion	5 Gt CO₂ per year
Land Use Only	$70 billion	4 Gt CO₂ per year
Combined Impact	$320 billion	9 Gt CO₂ per year

Modelling results show that land use policies are important for the cost-effectiveness of climate change mitigation. The comprehensive approach of integrating terrestrial and energy systems could further lower the cost of meeting the same mitigation target, consistent with findings of other studies. Meanwhile, the potential sellers and buyers in the virtual carbon market change depending on whether land-use mitigation measures are included or not.

Within the analysis there is the opportunity to look at a country such as Brazil and get some indication of the benefits for that country should Article 6 be fully implemented and then used to its maximum potential. With the inclusion of nature based solutions, Brazil, along with countries in similar latitudes in Africa, becomes one of the largest sellers of carbon units through to 2050, with China flipping to become a buyer.

The table below, extracted from the University of Maryland study, explores in more detail the implications of the inclusion of land-use mitigation measures for Brazil and the use of them under Article 6. In the fossil fuels and industry only scenario, Brazil is shown to be a marginal seller until 2025 and then switches to become a buyer after 2030. The inclusion of land-use mitigation measures under Article 6 contrasts sharply with this scenario. Brazil takes on the role of a prominent seller in the international carbon markets, which increases over time (as opposed to the decreasing trend in the fossil fuels and industry only scenario). Associated financial gains are also significantly larger and increase over time, as shown in the table.

International trade for Brazil through Article 6 (positive = seller; negative = buyer)
	2020	2025	2030	Units
Fossil Fuels Only	0.05	0.017	-0.049	Gt CO₂
Fossil Fuels Only	0.66	0.49	-1.88	US$ Billion (2015)
Fossil Fuels and Land Use	0.582	0.823	0.932	Gt CO₂
Fossil Fuels and Land Use	1.62	8.46	18.41	US$ Billion (2015)

The financial benefits associated with Article 6 cooperation, especially with the inclusion of land-use mitigation measures, are reflected in the GDP gains showed in table below.

Net GDP change for Brazil through use of Article 6 **
	2020	2025	2030	Units
Fossil Fuels Only	0.38	0.22	0.42	US$ Billion (2015)
Fossil Fuels and Land Use	1.61	8.27	17.66	US$ Billion (2015)

** Note that here are always gains in GDP growth as a result of Article 6 cooperation on NDC achievement but gain for Brazil are expected to be much larger as a result of the inclusion of nature based solutions under Article 6.

The University of Maryland analysis clearly shows the benefits of Article 6, but importantly it brings into context the scale of change that emerges for some countries when nature based solutions are incorporated within the carbon markets that will operate under Article 6. In the case of Brazil and the potential it has to develop these natural carbon sinks, the benefits rise towards US$20 billion per year by 2030, which could bring considerable economic growth to the Amazon region and encourage landholders to look at reforestation options. However, that potential can only be unleashed if Article 6 is designed to incorporate nature based solutions when the national negotiators sit down at COP25 in Madrid to finalize the rule book.

How might Article 6 work in practice?

dchone October 11, 2019

This is a critical year for Article 6 of the Paris Agreement. The ‘rule book’ wasn’t agreed at COP24 in Katowice, so the focus of negotiations at COP25 in Santiago will largely be on Article 6. This is the section of the Paris Agreement that sets out the framework under which cooperative action can be organised between Parties with a view to achieving their Nationally Determined Contributions (NDC). While cooperative action could take many forms, Article 6 is being negotiated as a carbon trading framework. There are very significant benefits in doing this, as recently shown in new work from the University of Maryland.

There are a number of interpretations of how Article 6 should work, hence the lack of agreement in Katowice, but the text in the Paris Agreement is really very clear. As I recently discussed, the underlying issue is the implication of the rules. A simple illustration helps explain Article 6 and can show why it is so important, why robust accounting is essential and why it can help deliver an overall reduction in global emissions.

In the illustration below, we have three countries (A, B and C) and the aviation sector. They each have a goal of zero emissions, but that is not the current state they find themselves in.

County A still has considerable emissions (100 units) from its heavy industry sector, but with no local abatement opportunities. As such, it is stuck and unable to make further reductions.
Country B has reached zero emissions but has not developed local options to easily sequester carbon dioxide as it has no need to do so.
Country C is undeveloped and has no emissions, but needs to develop energy infrastructure.
The aviation sector still has emissions (200 units) despite efficiency improvements and perhaps some fuel substitution. It has no immediate opportunities for further reductions.

These countries and sector decide to make use of Article 6 of the Paris Agreement to achieve their goals, enhance ambition and achieve further reductions. Investors develop a large scale air capture project in Country B, with geological storage. Emissions for Country B fall to -100, but they transfer units to Country A using Article 6.2 which underpins the original investment. Both A and B adjust their inventories accordingly with each now achieving net-zero emissions.

A similar transaction is executed between Country B and the aviation sector, but this time using afforestation as a natural sink. Country B remains at net-zero emissions as it adjusts its inventory and the aviation sector emissions can now be reported as 100 units. The transfer of nature based units, again using Article 6.2, has delivered real reductions for the sector.

But aviation still needs to take further action and as such encourages project developers to implement an avoided emissions project in Country C using the mechanism under Article 6.4. The project investment delivers reduction units that are then sold to the sector, bringing emissions to net zero. However, because of the need for a corresponding adjustment to their own inventory under the rules of 6.4, Country C now finds itself with 100 units of emissions, despite having no physical emissions in the country itself. This is because of the strict accounting rules of the Paris Agreement that are designed to ensure an eventual net zero outcome.

So in this example, Country C opts for a transfer from Country B under Article 6.2, with Country B further developing its natural sink potential to allow the transfer to take place.

After making all the local reductions that were possible and then utilizing the cooperative trading approaches offered by Article 6, the overall outcome across the countries and the sector is net zero emissions, which aligns with their desired goals.

Article 6 has delivered in many ways;

An overall reduction in global emissions has been achieved, with emissions falling from 300 units to net zero.
Ambition has been enhanced, with the countries and the sector all able to confidently target a net zero emissions outcome instead of stopping short of that goal.
Economic activity across the countries has been enhanced, with jobs and investment resulting from the transfers and project activity. Importantly, no country or the sector has had to reduce its economic output to meet emissions goals.
No double counting has taken place and clear carbon emissions accounting has ensured that the actions are visible to all and pass the critical test of environmental integrity.
Project developers have made use of the capabilities of Article 6.2 and 6.4 and invested with confidence, knowing that the transaction and supporting accounting systems behind Article 6 would deliver a return on their investment, without delay and without withholding of units.
The transaction under 6.4 delivered valuable revenue to another developing country through its share of proceeds provision (Article 6.6).

While the above is a very simplified illustration, it nevertheless shows the importance of the market oriented aspect of Article 6 in delivering the goals of the Paris Agreement. In addition, there is Article 6.8 which will be used to deliver non-market oriented approaches, such as the Kigali Amendment to the Montreal Protocol. With regards the market provisions of Article 6, early and clear implementation of the rule-book, embracing the clear intent of the Paris Agreement as shown above, is the essential next step.

What happened to that vacation offset?

dchone August 19, 2019

With many people in the Northern Hemisphere taking vacation at the moment, some may have clicked that button on the bookings website to offset the emissions from their air travel, cruise ship or even hotel. But what happens when the button is clicked?

In a recent article, the Guardian explored the nature of the voluntary carbon market and the wealth of project types that may be triggered as a result of that click. But they didn’t explore the very nature of the voluntary market from a carbon accounting perspective. This is where the Paris Agreement should change everything.

Today, as the Guardian article notes, that click leads to a project of some description executed through the voluntary carbon market. This is a market that has arisen over the years in the absence of cross-border compliance markets for regulating the emissions of carbon dioxide. Compliance markets are created and regulated by mandatory international, regional, and sub-national carbon reduction schemes such as the European Union’s Emissions Trading Scheme (EU ETS), the California Carbon Market and the largely defunct Clean Development Mechanism regulated by the Kyoto Protocol. By contrast, the voluntary markets function outside of the compliance markets and enable companies and individuals to purchase carbon offsets on a voluntary basis. For example, individuals who seek to offset their CO₂ emissions and companies who would like to become climate neutral can buy an equivalent in terms of carbon credits to “neutralize” or offset their carbon footprint.

The issue that isn’t explored by the Guardian relates to the legal title to the carbon reduction. In an emissions trading system, legal title belongs to the owner of the carbon unit created by the system, which then gives that owner the right to surrender it against their emissions in complying with the rules of the trading system. But in the voluntary market this isn’t as clear, even though the units are widely referred to as offsets which therefore implies that the reductions they represent belong to the emitter. The word offset is derived from financial markets where an offsetting transaction is an activity that, in theory, exactly cancels the risks and benefits of another instrument in a portfolio. Offsetting transactions are risk management tools that allow investors and other entities to mitigate the potentially detrimental effects that could arise if they cannot simply cancel the original transaction.

But what about the title to the reductions in a project activated through the voluntary carbon market? In the new world of the Paris Agreement, governments have created Nationally Determined Contributions (NDC) in which a plan is developed that shows how the country in question will reduce its emissions. For example, Kenya has stated that it will undertake an ambitious mitigation contribution and seek to abate its GHG emissions by 30% by 2030 relative to the business as usual scenario of 143 MtCO2eq; and in line with its sustainable development agenda. This is also subject to international support in the form of finance, investment, technology development and transfer, and capacity building.

When the click leads to a project in Kenya and that project is successfully executed, the emissions reduction achieved will be swept up in the assessment of Kenya’s greenhouse gas emissions at some point in the future when they are reporting out against the NDC to show how they have achieved their contribution to the Paris Agreement. As such, the voluntary project has been useful for Kenya, but its impact will have been reported as part of the Kenya NDC, which means that it isn’t technically an offset transaction against emissions in another place. This is because the project has helped Kenya and presumably eliminates the need for them to find yet more reductions in their economy to deliver on the NDC – the notional cap that they have placed on their emissions is, in part, fulfilled by the project. So the voluntary market is meeting a very specific need; it is helping finance reductions in other places against the NDC covering that location. This means it isn’t strictly an offset against emissions in the buyers location, even though a reduction clearly took place and was financed by the offset purchaser.

Under the Paris Agreement and Article 6, all this potentially changes, but it depends on the nature of the transaction. The voluntary market could continue as discussed above, as a financing mechanism for reductions in other places, or it could evolve into a fully accounted and tradable unit. In the latter case, when the unit is created in Kenya (perhaps under Article 6.4) and exported, it will trigger a change in their NDC and a change in the NDC of the country in which it is used in. Both NDCs will be adjusted such that overall global emissions remain on the same pathway. Paris is strict about double counting. The unit would also be formally recognized by both governments so title would transfer through the transaction, but the unit would now be helping the country in which the offset was purchased meet its NDC, rather than the country in which the project was executed.

A final case could see only the project host country adjust its NDC due to the export of the unit, but the importing country makes no change. The carbon title therefore remains with the offset purchaser. The unit is not used to help either country meet its respective NDC. When the unit is retired (held in perpetuity by the offset purchaser), it then represents a real offset against emissions and it takes the world slightly closer to the goal of the Paris Agreement than would otherwise have been the case.

It is still early days for the Paris Agreement and the rules of Article 6 for cross border trade of units have still to be agreed. As such, the voluntary market will continue under the current procedures. But as the Paris rules get going, expect to see things change. A further complication will be the application of these units towards flights where the emissions from the flight are already being accounted for through the new aviation emissions offset system, CORSIA, but that is for another post.

In the meantime, enjoy your vacation!!

Why is Article 6 so contentious?

dchone July 8, 2019

The Parties to the UNFCCC convened in Bonn through the second half of June to continue discussions relating to the Paris Agreement, but particularly to make progress on the rule-book for Article 6 of the Agreement that remained held over from COP24 in Katowice.

Article 6 relates to cooperative approaches, but is largely being negotiated as the foundation element of cross-border carbon trading between Parties or private entities (e.g. companies) within the jurisdiction of those Parties. Only Article 6.8, which is specifically defined as a non-market mechanism is being dealt with differently. The remainder of Article 6, i.e. provisions 6.2 to 6.7, deal with the prospect of cross border trade of mitigation outcomes, broadly defined in terms of tons of carbon dioxide.

Article 6 is simple in concept but has proven difficult to negotiate. The concept is that Nationally Determined Contributions (NDC) may be best achieved by cooperating with another Party, essentially in the same way as facilities within a cap-and-trade system trade allowances as a route to minimising the cost of compliance; i.e. facilities balance their needs by reviewing their own options to reduce emissions or purchasing allowances from other facilities that can more readily make reductions against some allocation they may have received from the government or bought in government auctions. The overall cap on the system doesn’t directly play a role for each facility, but indirectly governs the entire system and allows it to function and for reductions to proceed against a financial metric.

The challenge, is that the Paris Agreement is not based on allowance allocation, cap-and-trade architecture or carbon units, but only on a willingness to reduce emissions at national level against a nationally determined plan. However, to enter into a cooperative arrangement, some form of accounting must be implemented such that it is transparent to the cooperating Parties and others that there is no double counting of emissions and no relaxation of NDC goals. That accounting requires carbon unitization of the activities taking place and more importantly unitization of the NDCs themselves such that it is apparent to all what is going on.

While Article 6 is a purely voluntary framework and Parties are free to sidestep it and simply deliver their NDC goals, many Parties are keen to use the provisions of the Article to lower costs and attract inward investment in emission reduction activities. But it takes the cooperating Parties into the world of emissions accounting, which is where the controversy starts. Parties making use of Article 6 will inevitably be drawn into carbon budgets as the pressure on transparency and environmental integrity grows.

In Bonn the Parties spent a good portion of the time attempting to resolve numerous issues that remained from COP24. Almost all are related to accounting, issues that vanish entirely if carbon budgets begin to be applied to NDCs, as the United Kingdom has done through legislation. But a budget, however it is implemented, implies a limit of some sort, an idea that numerous Parties are not yet prepared to entertain. There are good reasons behind this, including the concern that development brings with it significant industrial activity, almost all of which is based on the use of fossil fuels, but in many cases, coal.

But a budgetary approach brings a quantitative simplicity to Article 6 that is impossible to match through qualitative assessment, as was the case for the Clean Development Mechanism of the Kyoto Protocol. Specifically, applying a clear and transparent numerical approach resolves issues related to additionality, overall reduction in global emissions, corresponding adjustments, double counting, transfer to CORSIA, NDC coverage and the handling of CERs and AAUs left over from Kyoto Protocol days.

But a robust numerical approach with carbon budget implications leads Parties into a world they sought to avoid under the Paris Agreement, yet it is one that must inevitably emerge so as to apply a climate lens to the energy transition and guide it to net-zero emissions. As Parties negotiate the terms of Article 6, there are perhaps two clear ways forward. One is to compromise on all aspects of the needed accounting regime, but risk ending up with an approach that does little to foster cooperative action and then operates at a small scale as a niche activity. It is hard to see how this serves anyone well. The other is to recognise that this is a voluntary mechanism and to implement the required accounting, which Parties will gradually adopt and use as they are ready.

The world in which carbon dioxide is meticulously and transparently accounted for also leads to carbon pricing. Little wonder it remains contentious and is taking significant time and effort to resolve.

Encouraging CCS Deployment

dchone April 18, 2019

Recently I attended a workshop hosted by KAPSARC on the potential for a dedicated mechanism to spur the deployment of carbon capture and storage (CCS). Technology focused mechanisms have worked well within the suite of energy policies used over the past two decades to reduce emissions. Perhaps the best example has been the use of tradable renewable energy certificates (REC) to force deployment of solar and wind within the electricity system. In a REC based policy framework, suppliers may be required to deliver a certain percentage of renewable electricity, which they do by surrendering RECs purchased from the market, with are supplied by various generators depending on the amount of renewable energy they generate.

At the KAPSARC workshop, the proposal the participants discussed was the creation of a certificate that represents one ton of carbon dioxide stored geologically. KAPSARC published an initial discussion document outlining the concept, while the workshop itself focused on how the mechanism might be used, where there are opportunities today and what the future might look like for such a mechanism. In the case of the latter, I kicked off this discussion with a view from the Sky Scenario.

Source: Shell Sky Scenario

In 2070, Sky achieves net-zero emissions in the energy system, but the use of fossil fuels is far from over. Further, there is a distribution by country for achieving net-zero emissions which spans from the 2040s to nearly 2090. By 2070 there are countries at net-negative emissions and countries still showing overall net emissions, but the global system is at net-zero. With fossil fuels still in the energy system (albeit declining), carbon capture and storage plays a critical role in achieving net-zero. The goal is reached by matching remaining emissions to sinks, which is done through commercial and government to government transactions. These transactions could well be based around a storage unit, as discussed in the KAPSARC publication.

The big question facing us today is the process by which such a storage unit is initially developed and then put into use. This is important as the deployment of CCS over the coming thirty years is a critical pre-cursor to achieving net-zero emissions, in that considerable CCS capacity must be in operation by the beginning of the second half of the century to ensure net-zero emissions is achieved as early as possible thereafter.

The participants put forward various approaches, but all involved some form of obligation to deploy CCS against future emissions, with that obligation growing over time. This is similar to the way in which renewable energy requirements grew against overall electricity production. With very little CCS capacity deployed today and realizing that it takes several years between first concept and an operating plant, it might be that by 2030 the obligation in certain markets was just 1-2% storage against emissions. For example, in the EU large emitters sector (covered by the EU Emissions Trading system or EU ETS) with some 1.5 billion tonnes of emissions in 2030, 15-30 million tonnes would require capture and storage under such a proposal, or some 20 medium sized CCS facilities. This is against two in Norway today and none in the remainder of the EU.

Such a proposal in the EU, or for that matter any market, would require careful integration with existing policies (such as the EU ETS) and both significant lead time and certainty to trigger investment decisions in CCS and allow time for such facilities to be built. With that in mind, the workshop also looked at where CCS could be integrated with existing policies with minimal change. One example discussed was the California Low Carbon Fuel Standard (LCFS) which trades within the broader scope of the California cap-and-trade system, but which deals only with the carbon intensity of transport fuels that have their own sub-targets. This system trades at well over $100 per ton of CO2 (compared to <$20 for the cap-and-trade system), more than enough to support a CCS project. In fact, the integration of CCS in this market has been a reality since the beginning of 2019, as reported by the Global Carbon Capture and Storage Institute (GCCSI).

A further discussion track was around the possibility of strong voluntary obligations. One workshop participant noted that such a move by oil, coal and gas producers could have considerable future option value, in that it could change the dynamic of the current trend to simply dismiss the future role of fossil fuels by ensuring that adequate CCS capacity would be available to be able to continue producing in a future environment of very high emission costs or even moratoriums on fossil fuel use.

A final but critical discussion was around the role of such a unit within Article 6 of the Paris Agreement. The need to match sinks against continued emissions in other locations and across borders will be an essential element of achieving the balance called for in the Paris Agreement (i.e. what is widely referred to as net-zero emissions). The proposal that emerged from the discussion was to ensure that a clear bolt-hole is carved out for such a unit in the Article 6 discussions that will hopefully conclude in Santiago at COP25 in December of this year.

Variations of all the above have been under discussion in the side-lines of the climate policy debate for too many years now, with little to no real progress in terms of CCS deployment. The KAPSARC workshop was the first gathering to focus specifically on this subject and bring some concrete ideas to the fore. But more needs to happen for these ideas to take root. Thanks to KAPSARC for their diligence and tenacity in holding the workshop and encouraging the CCS community to build on and hopefully implement the ideas.

Note: Scenarios are not intended to be predictions of likely future events or outcomes and investors should not rely on them when making an investment decision with regard to Royal Dutch Shell plc securities. Please read the full cautionary note in http://www.shell.com/skyscenario.

Carbon pricing policy in 2018. Was it a year of progress??

dchone January 10, 2019

Carbon pricing remains at the centre of most government policy discussions on climate change, but in a year which saw the Intergovernmental Panel on Climate Change (IPCC) give an unambiguous warning on the need for mitigation action, carbon pricing policy development rather stumbled along.

Undoubtedly the highlight of the year was the restoration of the EU Emissions Trading System (ETS) to again become a meaningful mechanism, with prices rising to over €20 as EU growth gained momentum and allowance supply tightening. The recognition that the Market Stability Reserve would be a feature of Phase IV in the 2020s certainly contributed to this. Also in the EU, discussions opened around the need for an EU ETS floor price, following the successful example set by the UK which has seen coal almost vanish from the generation mix since their implementation of such a system.

Singapore also moved forward with the implementation of its carbon tax.

But outside the EU and Singapore it was hard to find any stellar examples of progress, although intent remains high in many jurisdictions. Rather, 2018 was a year troubled by a number of developments in the carbon pricing space;

In Canada, a new government was elected in the province of Ontario and true to their election manifesto the new Premier took rapid action to remove Ontario from the cap-and-trade system it had only recently joined with California and Quebec.
Also in Canada, the Federal government moved ahead with its backstop pricing mechanism which will kick in for individual provinces if they do not implement a price through some mechanism of their choice. While this was a positive development, the prospect of litigation from some provinces (either by the current provincial government or by an opposition in waiting) means that this program may have a bumpy ride in the years to come.
In Brazil there has been discussion for some time now on implementation of a carbon pricing policy, but this is unlikely to continue under the new administration.
In Australia, even the possibility of a carbon based policy being implemented seemed to create political turmoil. Nevertheless, Australia is not devoid of a mechanism in that the Safeguard Mechanism put in place with the Emissions Reduction Fund has created a secondary market for Australian reduction units on the back of some industrial facilities exceeding their safeguard cap.
In France, protests erupted late in the year on the back of a carbon tax implemented in the fuels market, although many other factors also lay behind the demonstrations. The government was forced to delay implementation.
Finally, the year ended with failure at COP24 to agree on the rule-book for Article 6 of the Paris Agreement. While the Article 6 mechanisms are not there to directly implement carbon pricing, their use would certainly help catalyze such developments in many economies.

In between the highs and lows of 2018, there was still progress. China announced further details of its upcoming cap-and-trade system and continues to make progress in implementing their plans and Kazakhstan is now looking to reboot their early system. The very long running discussion on a carbon tax continued in South Africa with the prospect of a system emerging in 2019, although the parliamentary process has yet to conclude.

But this is not the required profile of action for a world that is intent on reaching the goals of the Paris Agreement. That profile was illustrated by the May release of the Shell Sky Scenario which highlighted the extraordinary rate of progress required in this policy area in the 2020s. Whereas in 2020 Sky shows only modest uptake of carbon pricing, reflective of the situation today, by 2030 some form of carbon pricing is covering the bulk of the global economy at a level between $25 and $60 per tonne of carbon dioxide.

Sky Scenario carbon pricing profile (Source: Shell analysis)

Developments in this space need to pick up pace dramatically in 2019, but perhaps the transparency and reporting framework agreed at COP24 will help in that regard. While the Paris rulebook makes no specific demands on governments to implement policy, it will put a spotlight on the actions they choose to take and the mitigation they seek to achieve. Carbon pricing policy ought to see some uptick under such circumstances.

Overview of carbon pricing developments (Source: own analysis)

Note: Scenarios are not intended to be predictions of likely future events or outcomes and investors should not rely on them when making an investment decision with regard to Royal Dutch Shell plc securities. Please read the full cautionary note in http://www.shell.com/skyscenario.

The missing links after COP24

dchone December 18, 2018

With much applause and many congratulatory statements, COP24 in Katowice finally ended on Saturday evening, after a marathon flurry of activity to get the Paris ‘rule book’ completed. What emerged was a lengthy and detailed 130+ page set of texts that introduces national governments to a version of the detailed questioning and transparency requirements that companies currently face under various carbon disclosure processes and protocols.

For example, under the framework required to track the progress on nationally determined contributions (NDC), countries are required to advise;

Target(s) and description, including target type(s) (e.g. economy-wide absolute emissions reduction, emissions intensity reduction, emissions reductions below a projected baseline, mitigation co-benefits of adaptation actions or economic diversification plans, policies and measures, and other);
Target year(s) or period(s), and whether they are single-year or multi-year target(s);
Reference point(s), level(s), baseline(s), base year(s) or starting point(s), and their respective value(s);
Time frame(s) and/or periods for implementation;
Scope and coverage, including, as relevant, sectors, categories, activities, sources and sinks, pools and gases;
Intention to use cooperative approaches that involve the use of internationally transferred mitigation outcomes under Article 6 towards NDCs under Article 4 of the Paris Agreement;
Any updates or clarifications of previously reported information (e.g. recalculation of previously reported inventory data, or greater detail on methodologies or use of cooperative approaches).

A similarly detailed requirement was agreed for reporting on emissions and removals at the national level.

But the reporting also includes an aspect that is unique to developed countries, i.e. how they are helping developing countries with financial resources to deliver their mitigation and adaptation objectives. The text includes various requirements to itemize this help, such as listed below;

Year (calendar year, fiscal year);
Amount (in United States dollars and domestic currency) (the face value and, on a voluntary basis, the grant-equivalent value);
Recipient, including, to the extent possible, information on the recipient region or country and the title of the project, programme, activity or other (specify);
Status (disbursed, committed);
Channel (bilateral, regional, multi-bilateral, other (specify));
Funding source (ODA, OOF, other (specify));
Financial instrument (e.g. grant, concessional loan, non-concessional loan, equity, guarantee, insurance, other (specify));
The type of support (e.g. adaptation, mitigation or cross-cutting);
Sector (e.g. energy, transport, industry, agriculture, forestry, water and sanitation, cross-cutting, other (specify));
Subsector, as available;
Additional information, as available (such as project/programme details, implementing agency and to the extent possible, link to relevant project/programme documentation);
Whether it contributes to capacity-building and/or technology development and transfer objectives, as available.

Much of this already exists in other documents prepared by governments (e.g. for their overseas development aid budgets), but seeing it in one place and focused on a single issue will doubtless bring a new level of scrutiny.

But despite the hard work of the negotiators in Katowice, running into many nights, the Paris rule-book is lacking on two fronts, and both are arguably critical to overall success.

The first is an issue that is inherent to the Paris Agreement itself; it is fundamentally about guidance to countries rather than instructions. Reading through the text, there is great detail on NDC reporting and equally on the role of the UNFCCC in aggregating this information and presenting an impact assessment against the goals of the Agreement itself, but there is no concrete approach to bridging any gap that exists between what is being done and what is required.

Rather, this depends on some version of diplomatic peer pressure, with a committee established under Article 15 of the Paris Agreement to oversee compliance with the rule book, but this is primarily related to submitting the NDC, reporting back and submitting an emissions inventory. Closing the gap, which is clearly a task that needs to addressed, is handled through the global stock-take being used as advisory input by each Party when they come to resubmit their NDC. The text agreed in Katowice, emphasizes that;

. . . . the outputs of the global stocktake should focus on taking stock of the implementation of the Paris Agreement to assess collective progress, have no individual Party focus, and include non-policy prescriptive consideration of collective progress that Parties can use to inform the updating and enhancing, in a nationally determined manner, of their actions and support in accordance with relevant provisions of the Paris Agreement as well as in enhancing international cooperation for climate action.

The key question going forward is whether this approach will be sufficient to close the gap and how various countries will respond. While a collective process is essential to address climate change, we all know from personal experiences that some form of constructive finger pointing can often help break a collective impasse. The issue is always about how it is delivered so as not to disenfranchise members of the group.

In the Sky Scenario, released by Shell earlier this year, the story highlighted that the necessary emission reductions could only be delivered if various mechanisms to share common interests worked extraordinarily well, but in combination with a drive by leaders towards a certain outcome.

Source: Shell Sky Scenario

The last point in the above text which references international cooperation, leads to the the second issue with the ‘rule book’. After two weeks of deliberations on Article 6 of the Paris Agreement, being the role of cooperative approaches, no consensus emerged on the rules that should apply. I have discussed this Article many times, but in short it is seen by most as the foundation elements for trade in carbon units, ideally giving rise over time to a more structured global market which in turn facilitates delivery of NDCs. In Katowice, a number of points of disagreement on Article 6 were still outstanding on the Saturday evening. As such, Article 6 is still to be negotiated and the Parties agreed to attempt this over the coming year. It is the missing chapter in an otherwise complete Paris ‘rule book’ and should receive ‘main event’ status at COP25 in Chile, where it will be in good hands with a government deeply engaged on carbon pricing matters. A hoped for silver lining is that increased focus leads to an even more ambitious outcome for Article 6; relegating it to project mechanism status as a simple follow on from the Clean Development Mechanism of the Kyoto Protocol is downplaying its potential.

The disagreements were fundamental and related to the accounting provisions (i.e. the avoidance of double counting which is of paramount importance), the call by some Parties for a share of the proceeds arising from international transfers and transfer of units out of an NDC and into a system such as CORSIA, the latter also being an accounting issue.

In the end, a light version of Article 6.2 (transfers of units between countries) appears in the accounting provisions for Article 13 (the transparency framework), but this refers back to the provisions and definitions within Article 6, which have yet to be agreed.

. . . . .An emissions balance reflecting the level of anthropogenic emissions by sources and removals by sinks covered by its NDC adjusted on the basis of corresponding adjustments undertaken by effecting an addition for internationally transferred mitigation outcomes first-transferred/transferred and a subtraction for internationally transferred mitigation outcomes used/acquired, consistent with decisions adopted by the CMA on Article 6.

Moving forward without Article 6 could be a real barrier to progress. It is akin to developing the global trading regime for goods and services but not agreeing on the implementation of currency markets necessary to make it work. Carbon markets deal with emissions, which can be a very different activity to the provision of clean energy, such as through renewable energy investment. The latter activity should continue undiminished, but a lack of focus on activities such as carbon removal may mean that net-emissions do not fall as fast as they need to. These activities need a price on carbon and carbon unit trade is an essential aspect of this for price discovery and investment flow.

Much remains to be done in 2019 and beyond to put the world on a pathway that meets the goals of the Paris Agreement.

Note: Scenarios are not intended to be predictions of likely future events or outcomes and investors should not rely on them when making an investment decision with regard to Royal Dutch Shell plc securities. Please read the full cautionary note in www.shell.com/skyscenario.