Category: CDM

Article 6: The importance of the corresponding adjustment

dchone December 13, 2021

With COP26 behind us and the Article 6 rule book complete, attention should turn to operationalising Article 6 and particularly the transfer process that is detailed in 6.2 but applies to 6.4 units when they are created. There is real enthusiasm for getting 6.4 up and running, but there is also concern about the environmental integrity and inherent ambition associated with the units created. The ambition discussion emerged at the time of the Paris Agreement and is embodied in 6.4(d) which requires delivery of an overall mitigation in global emissions. That in turn has resulted in an automatic 2% retirement of all 6.4 units that are created.

With a focus on ambition, we therefore might expect greater scrutiny over the selection of projects, the baselines chosen and the verification process. Certainly these were important aspects of the process surrounding the Clean Development Mechanism of the Kyoto Protocol (CDM). But Article 6 functions differently to the CDM, with one critical extra requirement – the corresponding adjustment. I have described this in several earlier blogs, but in short it functions as shown in the chart below;

In the example country A attracts inward investment for an avoided emissions wind project and exports 100 units to country B, which needs to reach net-zero emissions but has no further local abatement opportunities to call on. Under the transfer provisions of 6.2 country A adjusts its nationally determined contribution (NDC) accounts by 100 units as a corresponding adjustment for the sale, but then must take enhanced domestic action to maintain its net zero emissions NDC goal. In the example this comes in the form of additional natural sinks for which it has abundant potential. The difference with the CDM is that the last step would not have taken place.

The important action here, other than the investment that delivers energy infrastructure to country A, is the corresponding adjustment and the subsequent domestic actions it triggers. It is perhaps more important than a focus on the project itself.

Project verification leading to the issuance of emission reduction units (ERU) focuses on numerous factors, but the stringency of the chosen baseline was always important in the CDM. A generous baseline, for example arguing that the national alternative to wind was coal when in fact natural gas was the more likely outcome, would mean more reduction units being issued and a potentially larger carbon trading income for the project. But it also meant more units being sold into the international market, possibly undermining global ambition.

In the Article 6 process, a generous project baseline may result in an ‘own goal’ of sorts. When a project is set up under Article 6.4 it creates an economic incentive for the project in the form of carbon unit income, but at the same time it creates an economic liability for the host country due to the additional domestic actions that must be taken to balance the NDC. How governments ultimately deal with this liability remains to be seen, but allowing excessive credit issuance will likely be a non-starter as this will simply deepen the national liability to balance the sale made.

For quantified NDCs the corresponding adjustment rule is as follows;

Each participating Party with an NDC measured in t CO₂ eq shall apply corresponding adjustments pursuant to paragraph 7 above, resulting in an emissions balance as referred to in decision 18/CMA.1, annex, paragraph 77(d)(ii) of the annex to decision 18/CMA.1, reported pursuant to paragraph 23 of this guidance, for each year, by applying corresponding adjustments in the following manner to the anthropogenic emissions by sources and removals by sinks from the sectors and GHGs covered by its NDC consistently with this chapter and relevant future decisions of the CMA:

Adding the quantity of ITMOs authorized and first transferred, for the calendar year in which the mitigation outcomes occurred pursuant to paragraph 7 above;
Subtracting the quantity of ITMOs used pursuant to paragraph 7 above for the calendar year in which the mitigation outcomes are used towards the implementation and achievement of the NDC, ensuring that the mitigation outcomes are used within the same NDC implementation period as when they occurred.

The above offers a very transparent approach to the adjustment, but of course not every country will have a quantified NDC. Where the basis of an NDC is policies and measures, then the rule shifts;

. . . to the anthropogenic emissions by sources and removals by sinks for those emission or sink categories affected by the implementation of the cooperative approach and its mitigation activities and by those policies and measures that include the implementation of the cooperative approach and its mitigation activities . . . .

Adding the quantity of ITMOs authorized and first transferred, for the calendar year in which the mitigation outcomes occurred, pursuant to paragraph 7 above;
Subtracting the quantity of ITMOs used pursuant to paragraph 7 above for the calendar year in which the mitigation outcomes are used towards the implementation and achievement of the NDC, ensuring that the mitigation outcomes are used within the same NDC implementation period as when they occurred.

Emissions accounting and corresponding adjustments on the above basis is more challenging than via explicit carbon budgets and may not be purely quantitative in nature in that a qualitive decision will need to be made in defining the scope of the categories and activities affected. Over time we may see Article 6 being a catalyst for change in NDC structure, with countries that wish to attract project investment and engage in ERU export shifting to quantified NDC and the transparency that they bring. This gives greater certainty to receiving countries that the transaction has not somehow increased global emissions. Ultimately that puts the world on course for more rigorous carbon budget management, which is where we need to be to meet the goals of the Paris Agreement.

Arguably the environmental integrity of Article 6 sits more with the corresponding adjustment than with the project itself and its verification. Provided the adjustment is transparent and the change is balanced by other actions by the host country, then the integrity of the project is less important than would otherwise be the case. It may transpire that receiving countries accept units more on the basis of how the corresponding adjustment is executed than on the precise baseline and emission reductions achieved by the project. It also means that verifiers may need to shift their approach from local analysis of a project to a broader look at the NDC, its reporting and the way in which the host country counts emissions.

The lesser told story of COP26

dchone November 18, 2021

The much anticipated but delayed COP26 has come and gone, with many articles and commentary focussing on whether 1.5°C is still alive. I commented on this at the start of COP26 and although some additional enhanced NDC pledges have been made since then and there is a new goal to end deforestation by 2030, the situation remains largely unchanged. Apart from one thing! COP26 delivered an agreement on Article 6 of the Paris Agreement.

Article 6 was the last piece of the Paris Agreement to be negotiated back in 2015 and true to form it has become the last piece of the rule book to be completed. So why has it proved so contentious and why does it help keep 1.5°C alive?

The Article outlines ways in which some Parties can choose to pursue voluntary cooperation in the implementation of their nationally determined contributions (NDC), but the sub-sections 6.2 and 6.4 have been negotiated primarily as carbon market instruments, designed to allow trading between Parties, through linking of emissions trading systems and cross border investment in mitigation and removals to create tradable carbon credits. Simply put, carbon markets and trading of carbon units unleashes a commercial engine that can operate on a scale far surpassing the limits of local domestic action. It helps align the energy transition with other global commercial activities, offering the potential for lower overall costs to society which in turn can enhance ambition. Trade is a powerful tool that is at the heart of the global economy and carbon trading can serve to unlock mitigation opportunities that would otherwise be neglected. As I discussed in a recent post, a potential future standstill in global emissions is brought to net-zero through Article 6 cooperative action between countries and the aviation sector developing carbon removal opportunities in various parts of the world. Trade requires price discovery, so indirectly Article 6 helps in the development of liquid carbon markets and carbon pricing, although these don’t emerge from Article 6 itself but from national systems which are open to Article 6 transfers.

The newly agreed rules behind 6.2 are simple but powerful and importantly bring clarity to the issue of environmental integrity. Article 6.2 allows transfers between counties in carbon designated units, thus impacting the NDCs of the buyer and the seller. The buyer is able to meet NDC goals more cost effectively and the seller receives an income stream for domestic mitigation activities. This may seem like a straightforward approach to mitigation, so why has it proved so difficult to negotiate?

The rule for a transfer between Parties requires an adjustment to the related NDCs which brings with it a need to account for each NDC in carbon budget terms. Over time, this drives the Paris Agreement to operate more like a rigorous cap-and-trade system rather than a collection of national mitigation activities presented as a list of actions. With national actions based on a carbon budget architecture, transparency is vastly improved and actions are increasingly focused on mitigation rather than simply supplying more clean energy. The two may align but are not necessarily the same. With so much at stake, negotiators have been careful to get the rules right. Further, carbon budgets are easy to add up and derive a global total, which then puts pressure on the Parties when that budget exceeds the available capacity of the atmosphere for a given temperature limit. Ultimately, it may also open up the highly contentious question of who can use the remaining budget. While the Paris Agreement isn’t operating like this today, widespread use of Article 6 could accelerate such a development.

Article 6 also brings with it a mechanism to assign common units to a mitigation project, carefully defining it in terms of tradable carbon credits. These would be issued by a Supervisory Body operating as part of the Paris Agreement implementation. While 6.2 is essentially a bilateral transfer approach, 6.4 is a multilateral mechanism, introducing a notional Paris carbon currency. However, transfer of these units between countries will still follow the rules of 6.2. Article 6.4 follows on from the similar Clean Development Mechanism of the Kyoto Protocol, but with a clearly quantified transfer approach.

Both 6.2 and 6.4 are voluntary in that attainment of NDCs can be realised without them, but when used they bring the power of trade to the job of mitigation. Analysis of the benefits of such an approach by the University of Maryland found that international cooperation under a well-functioning Article 6 of the Paris Agreement could save as much as $250 billion per year by 2030. Translating this back into the potential for greater mitigation becomes tangible and meaningful in the already very narrow window of opportunity for limiting warming to 1.5°C.

Glasgow doesn’t mean job done on Article 6, but it does set the stage for activities to commence. The onus is now on national governments to encourage the use of these mechanisms, by allowing their mitigation activities to be open to Article 6 transfers. This could start with well-developed systems such as the EU ETS recognizing 6.4 units, particularly if they are associated with carbon removal projects which the EU will need to meet its goal of net-zero emissions by 2050. Successful implementation could also allow the EU to consider an earlier NZE goal if required to keep 1.5°C in play. But given that the Article 6 rule book was finally agreed in the United Kingdom, perhaps the British government might be the ones to step up and allow Article 6 to flourish within the new UK ETS. After all, in the wake of Brexit trade has become the topic of the day in the UK.

Article 6 has been a hard won policy development, but it’s completion in Glasgow makes COP26 a success, even as some commentators have pronounced some disappointment with the precise wording of the Glasgow Climate Pact. We should thank the negotiators for their efforts over many years and reward their long nights at various COPs with rapid and successful implementation.

Article 6 at COP26

dchone October 11, 2021

My home country, Australia, seems to reside permanently in the international climate doghouse, but a closer look reveals that they have made steady progress on some of the less advertised fronts related to mitigation. This was highlighted again recently when the government’s Energy and Emissions Reduction Minister Angus Taylor announced that carbon capture and storage (CCS) projects would be eligible for emission reduction credits.

This might seem like a distraction to some, but Australia has been forging a clear path towards growing its carbon removal capacity for some years now. The Federal Emissions Reduction Fund (ERF) has long targeted opportunities in soil carbon, forest management and reforestation and now CCS is added to the list. Short of a miracle in energy technology development and deployment, the current mechanisms for energy supply do not hold within them a net-zero emissions solution available within 30 years, so it is only through the addition of direct carbon dioxide management in the form of removals that the goal of the Paris Agreement can be met. Unfortunately, this doesn’t seem to be widely appreciated, with the exception of the United States and their 45Q tax incentives for CCS, Canada with their early demonstration projects and Australia with its behemoth Gorgon CCS project, creation of the Global Carbon Capture and Storage Institute and domestic focus on removals. Other countries are now scrambling to establish similar initiatives, but are somewhat lagging.

The case for CCS and carbon removals is an easy one to make – it emerges from any credible analysis of the energy system that accounts for likely future energy demand, real world deployment rates and the expected fossil fuel legacy that will persist into the 22^nd century even as significant reductions in use are made. Depending on assumptions, removals can stretch to a trillion tonnes of carbon dioxide over the course of the century. It is only in a scenario with a very constrained future energy demand that removals become less important, but still don’t disappear. The chart below, which I have posted before, shows the four IPCC 1.5°C archetype scenarios (P1, a high sustainability consciousness develops across society, to P4, a technology driven society with high energy demand and technical solutions to environmental issues) and the Shell Sky 1.5 scenario – all require carbon removals. In the P1 scenario sink use is quite low, highlighted by an end to land based anthropogenic emissions and the subsequent development of the land as an enhanced sink from mid-century on, at about 5 Gt per year drawdown of carbon dioxide. P1 makes no use of geological storage. By contrast, the P4 scenario makes very extensive use of geological sinks with BECCS playing a substantial role even as land based emissions are eventually reigned in.

So how does all the above relate to COP26? Of course ambition is very much on the agenda and removals are required to deliver on that ambition, but so are many other steps. However, one of the features of carbon removals is that they will likely have to emerge through cooperative action between governments. Remaining emissions and the availability of removal sinks probably won’t exist in the same geographies, so a global trade in emission sinks will need to emerge. This would happen under Article 6 of the Paris Agreement, which still remains as unfinished business after the rulebook negotiations at COP24 in Katowice. Article 6 establishes a framework for cooperative action between countries in realizing their NDCs, which includes trading carbon units across borders.

The charts below illustrate how a standstill in global emissions (at 300 units in the illustration) is brought to net-zero through cooperative action between governments and the aviation sector. Large scale cross border investment results from the development and trading of carbon units, including removals, that would otherwise not take place. This is why Article 6 is so important – it helps all sectors and Parties to the Paris Agreement reach net-zero emissions.

While the UK Government has many ambitious plans for COP26, and Article 6 is certainly among them, I believe that agreement on the Article 6 rulebook is the most important outcome needed from Glasgow. Apart from its future value to society, an agreement on this difficult piece of rule-making would demonstrate that countries can work together to achieve an outcome that may not be in their immediate self-interest. Article 6 brings a rigour to emissions reporting and accounting that we must have for net-zero emissions. It introduces concepts such as carbon budgets and emissions inventory adjustments for trade to take place, which progressively caps the emissions of nationally determined contributions and forces them towards exact quantification, rather than narrative description. Of course nations aren’t required to use Article 6, it’s voluntary, but once they choose to they must also choose accounting rigour.

After the failure to agree on the Article 6 rule-book at Katowice, great progress was made at COP25 in Madrid, but final agreement still wasn’t possible. Nevertheless, a text emerged that would do the job, although it was entirely bracketed. But the text did capture the key elements that are required for Article 6 to function;

Removals specifically referenced.
A simple but robust approach for adjusting nationally determined contributions (NDC – the national plan for emissions reduction and adaptation put forward by a country) when an Article 6 transfer takes place.
A centralized accounting and reporting platform, with a clear focus on the avoidance of double counting of mitigation actions.
The creation of a supervisory body for the 6.4 mechanism.
Specifications for the design of a 6.4 activity and subsequent issuance of associated emission reduction units.
An approach to meet the requirements for adaptation funding required under 6.6 of the Paris Agreement.
A transition arrangement for ending the Clean Development Mechanism (CDM) of the Kyoto Protocol. The CDM has left several countries holding project carbon units that they are keen to monetize so as to support the underlying internal project investment.
A simple framework giving some structure to Article 6.8, the non-market approach cooperation.

Nevertheless, some disagreement between countries remains and these issue will need to be resolved in Glasgow.

There is a set of issues related to the scope of an NDC and whether some activities that are in addition to the NDC and involved in a transfer should be subjected to the same adjustments as the Madrid text outlines. This feels like a distraction for two reasons; the NDCs should rapidly expand to cover all activities within an economy and if there are activities still not covered by the NDC, they have no place under Article 6 anyway as this provision of the Paris Agreement is about cooperation to achieve NDCs.

Another tough issue has been the need to give meaning and substance to 6.4 (d) To deliver an overall mitigation in global emissions. The proposal in the Madrid text is to cancel a portion of the emission reduction units issued to the 6.4 activity, but this is unnecessarily punitive. It also risks pushing all activities into simple 6.2 transfers, which would undermine the whole purpose of having a project based mechanism which is more suited to many countries. The discussions in Glasgow simply need to recognize that, by definition, a 6.4 activity and related transfer with NDC adjustments always results in an overall reduction in global emissions. This is illustrated in the diagrams above and is the inherent purpose of an emissions trading structure.

Finally, there is the lingering problem of how best to wind up the CDM and what then becomes of the projects still delivering reductions and the legacy unused CERs sitting in registry accounts. For projects that continue to deliver reductions, the answer seems straightforward – they continue to operate, produce CERs and these are transferred under the provisions of 6.2, which ensures corresponding adjustments to NDCs. In the case of legacy units, I think the IPCC have answered the question, both in the 2018 SR15 and the 2021 AR6 reports. Both reports show that the temperature rise is now around 1.2°C and both offer a carbon budget requirement from 1.1.2018 and 1.1.2020 respectively to ensure that 1.5°C isn’t passed. By rebasing the climate issue in 2020 (in the case of AR6), anything that happened before that is now irrelevant in that it is part of the 1.2°C baseline. The carbon budget they developed has subsequently informed Parties on their NDC requirements and is already being used by the UNFCCC to assess the NDC gap . Adding pre-2020 units to current mitigation activities is simply undermining the carbon budget calculation.

With an agreement hopefully reached on Article 6 in Glasgow, the spotlight will then turn to national governments to open up the possibility of cooperative arrangements. This could come through linking of trading systems, opening up trading systems to external units and encouraging the private sector to develop mitigation projects through Article 6.4. Importantly, governments should also follow the lead of Australia and develop protocols for removals, as these are the units that will be in particular demand as net-zero emission goals and targets need to be met. Europe, in particular, will need to accelerate its removals thinking, an area where it is lagging in its mitigation efforts.

On to Glasgow!

Formulating an Article 6.2 transaction

dchone June 1, 2020

While Article 6 of the Paris Agreement remains in negotiating limbo, the text that emerged from Madrid for Article 6.2 gives a very strong indication of how countries view this mechanism and what will be required between Parties to see transactions begin to emerge. This includes the need for a carbon budget based Nationally Determined Contribution (NDC) or an NDC for which a budget can be formulated and a corresponding adjustment of NDCs to ensure environmental integrity and the avoidance of double counting. This is clearly spelled out in the Madrid text – III. Corresponding adjustments / B. Application of corresponding adjustments, paragraphs 8 to 13.

However, the actual buyer and seller will likely be private entities operating in the two countries making use of Article 6 and while the Paris rulebook is an important consideration in their transaction, the requirements of the rulebook will not be met by the transaction itself. Rather, the transaction of units between the buyer and seller must trigger a set of actions by the respective governments such that the Paris Agreement rules can be adhered to. This means that a link must exist between the inflow and outflow of carbon units within each economy and the implementation of the respective NDCs. Without such a link, the transaction effectively sits in the global voluntary market, which in turn means that the transaction cannot be used to meet compliance obligations that are crafted to guide the economy towards the goals described in the NDC.

The simplest such link that currently exists is where two emissions trading systems are joined, such as between Switzerland and the EU. Private entities operating within these systems can trade EU ETS allowances and Swiss ETS allowances, use the allowances for compliance in their respective country and know that there is some cascade upwards to the EU and Swiss NDC accounting. The approach is very simple, transparent and effectively a non-issue for the participants in the transactions. But what happens when there isn’t an existing trading system in place?

In the case of the Clean Development Mechanism (CDM) under the Kyoto Protocol, a project could be implemented in a developing country and upon agreement of the host country, the CDM Executive Board and a verifier, certified emission reduction units (CER) were issued. Apart from the checks already mentioned, these units were issued without context in that they didn’t relate specifically to a national plan to reduce emissions or have any economic bearing on the project host country other than bringing in valuable foreign investment. In the case of the buyer, the transaction was managed through the accounting rules of the Kyoto Protocol because the CERs would be added to the national inventory of assigned amount units (AAU) and then could be used for compliance against the national target. There was still a need for a system to cause the buyer to make the purchase, which in the case of the EU was the compliance requirements of the EU ETS.

But in the case of an Article 6.2 transaction, there is an impact on the national economy where the seller resides. Firstly, the requirement for a corresponding adjustment to the NDC means that an NDC carbon budget must be established. Secondly, the adjustment means that further reductions in country must be made to compensate for the sale, so a mechanism should ideally exist to ensure that those reductions are made and that they don’t cost more to implement than the proceeds from the sale. In the case of linked emission trading systems, the inherent design of the trading system provides this mechanism. A similar problem could exist at the buyers end, but the issue is often simpler. For example, the buyer may be using the units as an allowable alternative against payment of a carbon tax, in which case the decision to buy is based on the cost of available units from the recognized sources versus the payment of the domestic carbon tax.

Without an emissions trading system in place, the host country looking to generate income through the sale of units under Article 6.2 (ITMO or Internationally transferred mitigation outcome) has the perplexing problem of both tying the sale to the NDC and establishing whether the sale is of economic interest for the country. Depending on the eventual structure and agreement on Article 6.4, the same problems could also emerge. This means that the implementation of Article 6 will have a profound impact on the shape of mitigation policy in participating countries. It may be the case that the only way of solving this problem is through the implementation of a domestic emissions trading system, which makes Article 6 a catalyst for further uptake of cap-and-trade architecture (i.e. emissions trading systems). That would be a good outcome for all concerned.

Getting going with Article 6 of the Paris Agreement

dchone April 9, 2020

Article 6 was inserted into the Paris Agreement with a view to providing similar compliance flexibility to that offered by the trading mechanisms within the Kyoto Protocol (i.e. CDM, JI, AAU transfers). But given that the Paris Agreement doesn’t have strict targets and emissions management compliance in the way the Kyoto Protocol did, Article 6 was instead rephrased under the term cooperative approaches. The word trading (or trade) doesn’t appear in the Paris Agreement or its associated Decision Text.

The Kyoto Protocol was built from the ground up on an emission allowance basis (i.e. Assigned Amount Units or AAUs for developed countries), such that trade between developed countries (e.g. through Joint Implementation or JI) was strictly accounted for and the necessary adjustments made through the AAU system. But the protocol also included the Clean Development Mechanism (CDM), which offered the opportunity for developing countries to implement emission reduction projects and sell units into developed countries, which in turn incentivised a shift away from fossil fuels in the project host countries. However, the CDM could not make use of the two sided accounting system that AAU and JI trades offered. This was because developing countries didn’t have targets under the Protocol and therefore didn’t have AAUs matched to emissions. The solution, in a qualitative attempt to avoid double counting, was to establish rules around the additionality of the projects, in other words to attempt to show that the project was a real reduction and wouldn’t have happened anyway. As such, project baselines and analysis of counterfactual energy trends became important areas of study.

Within the Paris Agreement, Article 6.2 offers the means to transfer bilaterally agreed emission units between countries and Article 6.4 offers a mechanism to generate units under UNFCCC supervision from various national approaches, but with an emphasis on projects. In many ways, Article 6.4 mirrors the CDM of the Kyoto Protocol, although under the Paris Agreement the 6.4 mechanism can be hosted in any country for potential transfer of emission reduction units to any other country.

Whereas the Kyoto Protocol had strict accounting provisions, albeit with the caveat of the CDM transfers as described above, the Paris Agreement has no such architecture. Nevertheless, the requirement to avoid double counting (Article 6.2 and 6.5) has led to proposals for the Paris ‘rule book’ which will require a detailed emissions accounting approach. The proposed accounting text that emerged from COP25 in Madrid is shown in part below;

Under the 6.2 rule book:

8. Each participating Party shall apply corresponding adjustments . . . . .

. . . .

1. Where the participating Party has a multi-year NDC:

i. Calculating a multi-year emissions trajectory, trajectories or budget for its NDC implementation period that is consistent with the NDC, and annually applying corresponding adjustments for the total amount of ITMOs first transferred and used each year in the NDC implementation period and cumulatively at the end of the NDC implementation period;

9. Each participating Party with an NDC measured in tCO2 eq shall apply corresponding adjustments pursuant to paragraph 8 above, resulting in an emissions balance, reported pursuant to paragraph 23 for each year, by applying corresponding adjustments in the following manner to the emissions and removals from the sectors and GHG covered by its NDC:

a) Adding the quantity of ITMOs authorized and first transferred, pursuant to paragraph 8 above;

b) Subtracting the quantity of ITMOs used pursuant to paragraph 8 above.

Under the 6.4 rule book

IX. Avoiding the use of emission reductions by more than one Party

70. A host Party shall apply a corresponding adjustment for all A6.4ERs first transferred consistent with decision X/CMA.2 (Guidance on cooperative approaches referred to in Article 6, paragraph 2, of the Paris Agreement) . . . . .

In a Kyoto like world this could be easily implemented. NDCs would first be converted to emissions and AAUs assigned, which would give every country a clear carbon budget. As units were transferred between countries, then the necessary corresponding adjustments could be made via the AAUs. The challenge for the Paris Agreement and Article 6 is to do this in a world that doesn’t have such approaches built into the system but nevertheless needs them to fulfill the accounting requirements.

All the above brings me back to the current state of play on Article 6. Although some excellent text emerged from Madrid, it has yet to be agreed by all the Parties. In the interim, a number of organisations and some governments are pushing ahead with programs to operationalise Article 6 through demonstration. Most of these programs are focused on developing transfers through the 6.2 architecture, creating units under bilateral crediting systems and progressing with the physical transaction of the units between two parties, in some instances using technologies such as blockchain to track the transaction and ensure it is secure. The practitioners within these programs are looking at project baselines, calculating emission reductions, assessing additionality and building registries. But is this really the best use of their resources?

There is a solid twenty year history of project development and emission reduction unit issuance, starting in about 2000 with the likes of the World Bank and their Prototype Carbon Fund. This then led to the early days of the CDM and numerous other regulatory and voluntary market offset schemes. Collectively, we know how to do this and there is a high level of expertise in many institutions, companies and governments. We don’t need to learn this again. But not one of these offset schemes has ever dealt with the complexity of the problem posed by the Article 6 accounting requirements.

What we need are a number of good demonstrations of how corresponding adjustments can be implemented in practice and how they might work when dealing with the wide variety of Nationally determined Contributions (NDC) that currently exist. A prerequisite will be clear demonstrations of how robust emissions accounting can be applied to sometimes vague or non-economy-wide NDCs and to NDCs that have targets other than absolute emissions. Once there is trust around NDC accounting the application of corresponding adjustments is more straightforward and credible for everyone (including both the host country and recipient).

A demonstration program that seeks to establish best practice for corresponding adjustments will require strong cooperation between governments who are tasked with managing NDCs and national greenhouse gas emission inventories, the private sector who will be the likely investors and developers of projects and civil society who have a strong vested interest in environmental integrity and Article 6 itself. This is where the time needs to be invested to operationalise 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.

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.

Additionality and Article 6 of the Paris Agreement

dchone April 27, 2018

As negotiators gather in Bonn for another round of discussions on implementation of the Paris Agreement, various detailed issues are surfacing. One, which pertains to Article 6 of the Agreement, is the concept of additionality of actions implemented under the Article. In the Decision Text that accompanied the Paris Agreement, which is effectively the instruction manual for implementation, the need for additionality is referred to in relation to Article 6, Paragraph 4, the emissions mitigation mechanism. The Decision Text says;

Recommends that the Conference of the Parties serving as the meeting of the Parties to the Paris Agreement adopt rules, modalities and procedures for the mechanism established by Article 6, paragraph 4, of the Agreement on the basis of:

. . . .

(d) Reductions in emissions that are additional to any that would otherwise occur;

. . . .

The Article 6 negotiators have already grappled with this to some extent as the concept appears in the ‘Informal document containing the draft elements’, Annex XII.D, released in mid-March. In that document three possible definitions for additionality are considered, i.e.;

An Article 6, paragraph 4, activity to be additional by demonstrating that:

Option A {reference to what would otherwise have occurred}

(a) Emissions are reduced below those that would have occurred in the absence of the activity.

Option B {definition related to activity being beyond the NDC}

(b) The reduction of emissions goes beyond what would be achieved through the delivery of the NDCs of the host Party {further development may be required for implementation}.

Option C {definition linked to scope of NDC}

The concept of additionality stems from the Clean Development Mechanism (CDM) of the Kyoto Protocol, where Article 12.5 specifies that emission reductions are only to be certified under the CDM if they are additional to any that would occur in the absence of the certified project activity. In his 2009 paper ‘Additionality in the Clean Development Mechanism: Why and What?’, Benito Müller outlined a number of different ways in which additionality constraints under the CDM can be argued for. For example, there are arguments (i) from ‘environmental integrity’, (ii) from implementing Article 4.7 (of the Convention), and (iii) from the need to safeguard Annex I domestic mitigation efforts. Müller notes that the most important and widely used argument, is that additionality is needed to protect the environmental integrity of the regime. Being an offset mechanism, the CDM requires additionality to ensure that any ton emitted in developed countries against a CER must not increase the level of emissions permitted under the regime.

Under the CDM, additionality became something of a quasi-science, with baselines established for projects against which assessments could be made. The UNFCCC developed a toolkit, which recommended a scenario based approach for determination of additionality. But despite the effort put in, the analysis is largely subjective in nature. It all depended on what the assessor thought the future might bring, versus an objective numerical approach based on specific goals. The reason behind this is that developing countries didn’t have targets under the Kyoto Protocol, so environmental integrity could only be assessed, rather than measured.

Translating this concept to the Paris Agreement argues for new thinking on additionality in that the structure behind Paris requires all participating countries to have some form of target or goal embedded within their respective Nationally Determined Contributions (NDC). Paragraph 5 of Article 6 also specifies that emission reductions resulting from the 6.4 mechanism shall not be used to demonstrate achievement of the host Party’s nationally determined contribution if used by another Party to demonstrate achievement of its nationally determined contribution. This would happen if reduction units created under the mechanism were transferred to another Party without an accounting protocol. Doing so, would be classified as double counting. Within the Decision Text, there is a further requirement that double counting is avoided on the basis of a corresponding adjustment by both Parties for anthropogenic emissions by sources and/or removals by sinks covered by their nationally determined contributions under the Agreement.

The above discussion points to a more numerical and therefore objective approach to accounting for transfers under the Paris Agreement, in that corresponding adjustments are most easily executed when NDCs are quantified. I discussed this at length here. It also means that the more traditional complex assessment of additionality can be avoided, in that the corresponding adjustments ensure that environmental integrity is maintained.

If such a corresponding adjustment is made, then in the case of the host Party, the transferred quantity must be additional. This is because the host Party, having made the transfer, must find further, presumably lower cost, mitigation opportunities in their own economy to meet the stated goal of their NDC. This in turn means that the transferred actions were in addition to the requirements of the NDC, hence additionality can always be claimed. The quantification of systems is ideally done in units of CO2, but could even be in units of clean electricity or capacity in the case of renewable energy based NDCs.

Attempting any other assessment process to establish whether an activity goes beyond the NDC of the host Party is fraught with difficulty. In most instances this will be almost impossible to assess due to the difficulty of establishing the contribution of a single activity to the overall national emission pathway. Even if assessment is possible, it may be an extended period before the assessment can be made due to the need to collect and collate all the greenhouse gas data for the whole NDC. This will lead to any emission reduction units from the activity being untradeable in that they will carry considerable performance risk related to the outcome of an assessment that will be both uncertain and take a year or more to be delivered.

An extension of this approach to additionality is that units created under the 6.4 mechanism don’t require the same level of scrutiny as units created under the CDM. Should an activity produce an abundance of units which are then sold outside the host county, always a concern under the CDM through the application of a generous baseline, then the corresponding adjustment will act as a deterrent by demanding even greater mitigation efforts by the host. Although this isn’t a desirable way to operate the mechanism, it is nevertheless self-correcting.

The current informal text under consideration in Bonn doesn’t clearly identify the above route towards assessing additionality, but presumably Option B could fill this need. The text might then read;

The reduction of emissions goes beyond what would be achieved through the delivery of the NDC of the host Party. The host Party’s nationally determined contribution is adjusted numerically by an amount corresponding to any use of the emission reduction of said activity by another Party to achieve its nationally determined contribution, ensuring that additionality is established.

As the negotiators get down to their tasks in Bonn, they need to rethink additionality, jettison the model founded for good reasons under the Kyoto Protocol, and embrace a more quantified and objective approach to this subject.

Building a transition into Article 6

dchone September 26, 2017

It would seem that transitions are all important at the moment and while many may be focussed on the latest ideas for Brexit, I am actually talking about Article 6 of the Paris Agreement.

At the opening of the IETA Carbon Forum North America in New York last week, the Fijian Climate Ambassador gave a major push forward for Article 6, outlining to the attentive audience that it was perhaps the most important part of the Paris Agreement. Her assertion rested on the argument that a functioning global carbon market can enhance ambition. Looking some decades down the road, trade in carbon units can give confidence to nations to set net-zero emission goals, given that they will feel assured that the balance that needs to be reached against remaining emissions in their economy can be achieved by purchasing suitable units from a recognized international market. Without such a market, net-zero emissions is unlikely to be realized.

While the full need for such a mature global market may be many years away, the negotiators faced with the task of fleshing out Article 6 into suitable guidelines, rules and procedures need to consider that endpoint now. Although it is always possible to return to the table and build on existing systems, the history of this within the climate negotiations is not good. Back in May, IETA released a ‘straw-proposal’, outlining in very clear terms the necessary pieces required to further define Article 6. That proposal can now be found on the recently created IETA Article 6 Portal. It represents a desirable end-point for the shape of Article 6, which is a major step from where the international carbon market stands today.

But this may be insufficient for the current negotiators, who are also focussed on the near term and the role that carbon markets might play over the next five to ten years. Many have seen the Clean Development Mechanism (CDM) of the Kyoto Protocol bring much needed energy investment into their countries and some are keen for such projects to continue, rather than wait for a new round of activity to get going under a new mechanism; that could take some years. But the Paris Agreement will also bring fundamental changes to the accounting around these projects, given the existence of Nationally Determined Contributions. I discussed this in a previous post. But again, accounting of this nature may take some years to develop.

All the above points to a transitional arrangement; an approach which allows the structure, project pipeline and methodologies of the CDM to continue, but which sees the CDM subsumed into the new Article 6.4 mechanism as it emerges. Retaining aspects of the CDM and encouraging smaller energy development based projects in least developed economies and sub-national regions should be part of the new mechanism, but equally this mustn’t end up as the mechanism itself.

Article 6, including the transfer arrangements of 6.2, the mechanism of 6.4 and the non-market approaches of 6.8 must herald in trade and cooperative arrangements that operate on the gigaton scale, not kilotons and megatons as has been the case with the CDM. The mitigation challenge ahead is enormous and even the potential trade in a net-zero emissions world could be very large. Continued emissions from agricultural systems, chemical processes, smelters, aviation and shipping alone would require several gigatons of trade to offset with units representing removed carbon dioxide (i.e. sinks).

This points to a relatively short transition period, perhaps one or two of the five-year cycles for Nationally Determined Contribution (NDC) implementation and review. After that, if the Paris Agreement goals are to be met, NDCs should have expanded to cover all parts of every economy, therefore introducing the full accounting rules on which Paris is based. While project activity such as under the CDM will doubtless continue, it will need to be transparently accounted for within the NDC process. This in turn will change the nature of the trading arrangements for the reduction units coming from the projects.

The task for the negotiators in Bonn will be to find a balance between the shorter term needs of several Parties and the project investment pipeline that is important to their energy development, along with the creation of a new emissions mitigation mechanism and accompanying transfer provisions that are scalable and robust for the decades ahead. Transitional arrangements could be an important part of the solution.