Category: Kyoto Protocol

Is it time to open up the EU ETS again?

dchone January 20, 2022

As the new year gets going, the EU is facing much higher energy prices than it has had to contend with in the recent past, topped off with an escalating carbon price driven both by the energy price and the ambitious decarbonisation plans of the EU Commission. Starting in late 2020 at a price of around €20, the purchase of an EU allowance (EUA) in the EU Emissions Trading System (ETS) now costs between €80 and €90 per tonne of CO₂.

The current allowance price in the EU ETS provides a significant incentive to reduce emissions, including investment in substantial mitigation technologies such as carbon capture and storage (CCS). As such, this is a welcome and critically important change from over a decade of prices below €20 and a low of €3 where the system did little to encourage the energy transition. For much of the 2010s the ETS was awash in allowances, with the surplus brought about by the financial crisis and subsequent EU recession, the influx of units from the Clean Development Mechanism (CDM) of the Kyoto Protocol and the overlaying of other policies in the ETS sector, a practice that erodes the need for a specific carbon price and will undermine its impact.

We are now in a world where the EU ETS is driving substantial mitigation action, which is exactly what it is supposed to do. The question that arises is what comes next? One way of answering that question is to look at a scenario analysis of the EU net-zero emissions goal, such as in the Shell EU Sketch released by the Shell Scenario team a bit over a year ago.

A deeper look at the Shell EU Sketch highlights the ambition of the Fit for 55 (FF55) goal. Even in the scenario, the reduction planned under FF55 for the EU ETS sector isn’t fully met in 2030, but instead requires another five years of effort. In addition the energy transformation in the EU is not yet fully matching that of the Sketch. Take for example the build rate of CCS facilities in the Sketch versus the real world. At the rate of change in the Sketch, some 40 major (~ 1 mtpa each) CCS facilities need to be operating by 2030 and over 100 by 2035. The EU has finally started developing CCS clusters, but not yet fast enough to meet these goals. This implies that during the 2020s the EU ETS could see further price escalation if project activity does not fully match the reduction goals of the system.

The Fit for 55 package of measures and targets is extraordinary ambitious, contributing to the global reductions required to avoid passing 1.5°C of warming and setting up the EU for a landing at net-zero emissions in 2050. It does need a meaningful carbon price to usher in the transition, but in the Shell EU Sketch it rises to around €60 by 2030 and €200 by 2050 (but on a much smaller level of emissions than today). The current price of an EU allowance should usher in real change for industry and industrial processes, which is needed, but a continuing steep up-trend may also be a sign of a system that is becoming overly constrained by the rate of reduction required compared to the rate at which projects can be implemented.

When the EU ETS first started the Kyoto Protocol was coming into force and we all imagined a world of interconnected cap-and-trade systems, ambitious clean energy projects in developing countries and a resultant liquid global carbon market. With substantial demand coming from the Kyoto signatory countries with targets and good supply from clean energy projects, the resultant carbon market would be of sufficient size to deliver cost savings to all participants. Importantly, major price spikes could be managed. Almost none of this happened.

In the process, the EU ETS was designed with external hooks to make use of the mechanisms of the Kyoto Protocol (CDM and Joint Implementation or JI) and to connect with other systems. With the prospect of an Australian ETS about a decade ago the EU began early negotiations with the Australian Government to link the systems, but a change of government in Australia put an end to the Australian efforts. With the US leaving Kyoto and other countries making little use of the mechanisms, the EU ETS was left as the only real buyer of emission reduction units (CER) from the CDM. So it was flooded with them, contributing to the 2008 price collapse. The EU rightly closed the doors and it wasn’t until 2020 when they were partly reopened with a link to the Switzerland ETS.

Industry will be feeling the competitive pressure and rising fuel bills for citizens opens the door to voter anger when it comes to elections if the EU ETS price continues to rise without adequate relief valve mechanisms. The Market Stability Reserve (MSR) would offer some reprieve as it starts releasing banked allowances, but a longer term solution could also be found through Article 6 of the Paris Agreement. The EU ETS could open itself to projects executed under the 6.4 mechanism and transferred into the EU ETS via 6.2, along with the necessary corresponding adjustments to the counterparty country nationally determined contribution (NDC). I discussed the corresponding adjustment mechanism in my last post of 2021. The transfer provision under 6.2 also provides an opportunity to link with other trading systems, such as the recently created UK ETS.

Making use of Article 6 will be a very different experience to that with the CDM. This is a mechanism that operates between two nationally determined contributions (NDC), each with its own plan to reduce emissions, but each plan must be converted to a carbon budget for the period of the NDC in order to use Article 6. The rules for doing this were thrashed out in Glasgow and can be found in III.B of the decision. When the transfer between NDCs is executed, a corresponding adjustment must be made to the respective carbon budgets. This means that the selling country must make up the amount of the sale through additional actions within their NDC, which ensures that the overall reduction goals of the respective NDCs are maintained. Under the CDM, no such provision existed.

With robust Article 6 accounting standards, the EU can have confidence that environmental integrity is preserved and that real reductions are delivered through the ETS. This was always a concern with the CDM. However, there is a fine balance to be achieved when creating a relief valve in that a sharp fall in the carbon price is not helpful for investment. As such, the EU might initially look to trade with a very limited number of countries, such as those with similar ETS structures. The UK, New Zealand and South Korea could all fall into this category.

By opening up the ETS the EU will promote confidence in international carbon trading, which will become an increasingly important part of the mitigation toolkit as the world gets closer to net-zero emissions. This is because remaining emissions and the availability of sinks to balance won’t always be in the same jurisdiction. But most importantly, a larger trading system will lower overall costs for the same reduction goals or alternatively may promote greater ambition, which is certainly needed and was called for in the Glasgow Climate Pact. This will benefit everyone.

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 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!!

COP23: Much remains to be done

dchone November 17, 2017

As COP23 draws to a close, it offers an opportunity to reflect on the progress made by the UNFCCC and its efforts to address the issue of climate change. This year represents a quarter of a century since the adoption of the Framework Convention and 20 years for the Kyoto Protocol, which was agreed at COP3 in December 1997.

In that time, global emissions have risen by over 50%, hardly a testament to thousands of hours of negotiation, millions of air-miles by COP attendees and many long nights as disagreement erupted. Further, after three years of global emissions seemingly at a plateau, the delegates at COP23 were reminded in stark terms that there is still everything to work for; 2017 emissions are likely to show a 2% rise over 2016. While large uncertainties in the final number remain, emissions in China appear to have risen by some 3.5% (but with arrange of 0.7% to 5.4%).

Although emissions are the truest test of success, bringing them down and ensuring stabilisation of atmospheric carbon dioxide levels was not going to be easy. Nevertheless, the UNFCCC process has persisted and resulted in a world that is slowly mobilizing around the need to act and in many instances is acting. Arguably the process has delivered on several fronts;

The climate issue has grown in profile and almost every international leader talks about it, which in turn builds further interest.
The media is captivated by the subject, although opinions can vary markedly across publications and programmes.
The global fraternity of economists have risen to the challenge, with much written about policy measures and particularly carbon pricing. In the case of the latter, some 20-30% (depending on how China is viewed with its staged implementation) of the global economy now carries a price on carbon dioxide emissions, albeit only around $10 per tonne.
Most national governments and many sub-national governments have greenhouse gas emission based policies active within their respective economies.
Measurement, reporting and verification of greenhouse gas emissions has become a normal activity in much of the world.
Various carbon dioxide based trading units have evolved; from allowances in the EU ETS to project units under the Clean Development Mechanism of the Kyoto Protocol.
Carbon capture and storage has become a commercial technology, although deployment remains limited due to the level of carbon pricing.
A wide range of new power generation, transport and industrial technologies have rapidly evolved in response to the need for zero emission energy services. Significantly, Tesla unveiled its electric semi-trailer in the closing days of COP23.

The above list is not meant to be comprehensive and it could also be argued that some of this is unrelated to the UNFCCC, but without a central focus the lens on climate change would be a very different one. Nevertheless, COP23 highlighted two key issues;

The Paris Agreement did much to minimise the difference between developed and developing countries, with all nations required to submit plans for managing emissions within their economies. But as negotiators began work on the detail of the Paris Agreement ‘rule book’, the issue of common but differentiated responsibilities emerged at many meetings. The core of the issue is that industrial development without fossil fuels, but coal in particular, is still not possible. While much attention is focussed on micro-grids and decentralised renewable electricity in Africa, this is not the same as industrial development. Steel, cement, glass and chemicals require much more; so do the primary means of industrial transport, notably planes, ships and trucks (although Tesla would now argue the point on the last one). As such, emissions in developing countries are still likely to go in one direction, i.e. up!
Financing remains a sticky issue. The Paris Agreement offers various mechanisms and measures to help finance low carbon development in least developed and emerging economies, with a transparency framework to offer insight on progress. As work progressed at COP23 on the modalities surrounding finance, tension grew. One problem here is the definition itself. For many, it means the overall flow of private sector energy investment into developing economies, triggered by national policy, good governance, carbon trade such as that emanating from Article 6 and the attractiveness of projects. But for some, finance is thought of as tangible government to government assistance.

The political sensitivity of both these issues is heightened by the expected departure of the US from the Paris Agreement. It is unlikely that heroics from the US sub-national actors can compensate for that political destabilisation.

These and other issues will need to be resolved in the coming year if the full Paris ‘rule book’ is to be finalised by the end of COP24. In all likelihood, resolution will not be complete, but the process won’t falter either and the ongoing mobilization of global effort will continue. Negotiators will meet again in Bonn around the middle of the year and then in Katowice, Poland for COP24. In the case of the latter, the biggest fight is most likely to be over hotel rooms.

Putting the genie back

dchone August 25, 2017

As I have posted in recent weeks, my complete book on climate change is now out, under the title ‘Putting the Genie Back: Solving the Climate and Energy Dilemma‘. The publisher, Emerald Publishing Limited, has just made the first chapter available on-line so that you can try before you buy.

Their advertising for the chapter included a quote from President Barack Obama, which gives a hint as to where the title came from, but isn’t the whole story. In May 2014 the President had invited several meteorologists to the White House for exclusive interviews on the climate change report that the administration released earlier in the week. The president summed up the importance of the situation with one simple phrase: “it’s hard to put a genie back in the bottle.” The quote was part of a longer piece which was referring to the climate itself and the possibility of reaching a tipping point. He had said;

“I want to make sure that my children and my grandchildren are able to enjoy a beautiful day like today; that they’re not living in a more dangerous world. […] This is one of those things that is very difficule to recover from. Once we hit a certain tipping point, we don’t know exactly how certain weather patterns could end up resulting in catastrophe. It’s hard to put a genie back in the bottle.”

By that time my first e-book, which the current book also incorporates, was in the late stages of writing and I had already pencilled in the genie metaphor, although with other suggestions coming from friends and family, I wasn’t entirely sure. My use was never in relation to the climate itself, but to the use of fossil fuels. That particular genie has ushered in astounding progress for society, but it is also a genie that is hard to challenge. Nevertheless, we can, with carbon capture and storage representing a method of returning the carbon to the subsurface, effectively putting the genie back.

Even though my intended meaning wasn’t the same as the President, when he also used the phrase in relation to climate change it seemed like the decision was made.

Enjoy the pre-read and I hope you buy the book. My proceeds are going to the Centre for Climate and Energy Solutions (C2ES) in Washington D.C.

Paris ratification maths

dchone September 20, 2016

The joint announcement by the US and China that they would ratify the Paris Agreement and the more recent announcement by Brazil has raised the prospect that the agreement could enter into force sooner rather than later. Could it even happen prior to COP22 in Morocco or at least by the end of 2016? Certainly the G20 gave entry into force a boost when they included this in their Communique earlier this month.

We reiterate our commitment to sustainable development and strong and effective support and actions to address climate change. We commit to complete our respective domestic procedures in order to join the Paris Agreement as soon as our national procedures allow. We welcome those G20 members who joined the Agreement and efforts to enable the Paris Agreement to enter into force by the end of 2016 and look forward to its timely implementation with all its aspects.

Paragraph 1 of Article 21 of the Agreement specifies the requirements for entry into force as follows;

This Agreement shall enter into force on the thirtieth day after the date on which at least 55 Parties to the Convention accounting in total for at least an estimated 55 percent of the total global greenhouse gas emissions have deposited their instruments of ratification, acceptance, approval or accession.

The UNFCCC is running a tracker page and the exact status by country can be found on the UN Treaties site.

The combined emissions of China and the United States account for most of the 39% shown in the tracker picture above (mid-September). But of course they are only two parties, whereas 27 have ratified so far. Many of these are small island states, such as Barbados and the Cook Islands, some of which may be challenged in the near term by rising sea levels. So what might be a potential pathway to 55 / 55?

In terms of the number of parties, the Alliance of Small Island States (AOSIS) which consists of 44 members can get us most of the way there. With AOSIS and the 12 other non-AOSIS parties that had ratified by mid-September, the 55 Party threshold is surpassed. So it would appear that entry into force on this basis is achievable as other countries will doubtless come forward as well.

But 55% of global emissions may be a bit more difficult. The 40 AOSIS countries are all low emissions, so even their combined impact will be below 1% of global emissions. Starting with the USA, China and Brazil, the bar moves above 40% and with AOSIS, Norway, Peru and others who had ratified by mid-September it will approach 42%.

The 55 country and 55% line could easily be crossed with ratification by the other major emitter, the EU, but the parliamentary process in Brussels would normally push this into 2017. However, the political push behind the Paris Agreement can hardly be described as normal. At an EU leader summit last week, there was a strong indication given that EU ratification could happen in as little as three weeks.

If the EU fast track doesn’t happen, 13% of global emissions have to come from somewhere else. Some combinations of major emitters that could deliver this are as follows;

Australia, Japan, South Korea, South Africa, Thailand, Vietnam and Venezuela gets to about 10%.
Russia and India are at least 5% each.
Canada, Australia, Japan, Ukraine, Mexico, Saudi Arabia, Kazakhstan also combine to about 10%
Taiwan, Turkey, Algeria, Argentina, Egypt, Pakistan, Nigeria, Malaysia, Kuwait, Iran and Indonesia combines to about 10%.

Russia and India are clearly important, as was Russia with the Kyoto Protocol. But their early ratification isn’t essential. The other lists above clearly show that there are sufficient 0.6-3% countries to get this over the line. The first list, combined with Iran and Indonesia is but one example.

Given progress to date, a concerted push by AOSIS and perhaps the likes of the Umbrella Group (a UNFCCC collection of countries including USA, Australia, Japan and Canada amongst others), entry into force of the Paris Agreement is quite feasible in the nearer term. With the EU on board it is almost certain.

Revisiting global emissions accounting

dchone September 13, 2016

As COP 22 approaches and negotiators face the task of implementing the Paris Agreement, they will be required to interpret, expand on and operationalize the various Articles of the Paris text. One such piece is Article 6, which offers a framework that can support the establishment of a global carbon market. But the rules of that market may be very different to ones that have preceded it.

The design of the Kyoto Protocol resulted in a particular emissions accounting architecture that is a mixture of allowance allocation against a cap, combined with a provision for project based credits originating outside the cap (supplied by developing countries in the case of the Kyoto Protocol, i.e. non-Annex 1). These credits effectively raise the cap when they are imported into a covered system such as the EU ETS. Within the Kyoto Protocol, allowance allocation was handled through the Assigned Amount Unit against targets agreed by developed countries (Annex 1) and the most widespread crediting or offset system is the Clean Development Mechanism (CDM) which operates on a project by project basis in developing countries. This basic design has been translated into many jurisdictions, including locations such as California which is not covered by the Kyoto Protocol.

A feature of these systems is that the accounting normally handles the entities within the cap and the project outside the cap, but no attempt is made to account for the total greenhouse gas impact on the atmosphere or against a global goal to reduce overall greenhouse gas emissions. There is an implicit assumption that the sum of the various parts adds up such that the overall outcome is better than not having conducted the exercise at all. This happens because only a small percentage of the global economy sits under a cap, so there is no mechanism available to account for the total impact. This is one reason why some Parties challenged the appropriateness of the Kyoto Protocol itself.

A further issue related to the current structure is the macro accounting of the external credit. Projects vary in type, ranging from clearly measurable emission reductions (e.g. capturing land-fill methane) to notional reductions (e.g. a wind turbine is built, but the alternative might have been more coal). Particularly in the case of the latter example which is an energy mix question, there is normally no resolution between the local project and the overall energy mix direction of the host country. A key question is typically left unanswered; if the import of credits into a cap-and-trade system raises the cap, has there been an equivalent, albeit probably notional, decline elsewhere.

But as the Paris Agreement starts to take hold, this will likely change. The Durban Platform, established at COP17 to create a global climate agreement applicable to all to replace the Kyotol Protocol, was designed to address these issues.

The Paris Agreement is built on the concept of Nationally Determined Contributions (NDC). These are set at national level and offer a direction of travel for a given economy in terms of its energy mix and/or greenhouse gas emissions. Although the first set of NDCs offered in the run-up to COP21 were varied in nature and in some cases only covered specific activities within the economy, over time they will likely converge in style and, for the Paris Agreement to deliver, must expand to cover all anthropogenic greenhouse gas sources.

The NDCs also lead us down another path – that of quantification. The first assessment of NDCs conducted by the UNFCCC in October 2015 and then refreshed in May 2016 required the quantification of all NDCs in terms of annual emissions and cumulative emissions through to 2030. This was necessary to establish an equivalent level of warming of the climate system, which is driven largely by the cumulative emissions of carbon dioxide over time. Without such an assessment, the UN cannot advise the Parties on progress towards the aim of the Paris Agreement.

The UNFCCC didn’t have a full emissions inventory on which to base this calculation, so they established one from the best data available. But Article 13 of the Paris Agreement introduces a transparency framework and calls on Parties to regularly provide;

A national inventory report of anthropogenic emissions by sources and removals by sinks of greenhouse gases, prepared using good practice methodologies accepted by the Intergovernmental Panel on Climate Change and agreed upon by the Conference of the Parties serving as the meeting of the Parties to the Paris Agreement;

Information necessary to track progress made in implementing and achieving its nationally determined contribution under Article 4.

The foundation for transparency is measurement and reporting, which further implies that emissions quantification is a foundation element of the Paris Agreement. Although nationally determined and always voluntary, the Agreement effectively establishes a cap, albeit notional in many cases, on national emissions in every country. The caps are also effectively declining over time, even for countries with emissions still rising as development drives industrialization.

Article 6 introduces the prospect of carbon unit trading through its internationally transferred mitigation outcomes (ITMO) and emissions mitigation mechanism (EMM). Text in paragraphs 6.2 and 6.5 is included to avoid any possibility of double counting;

. . . internationally transferred mitigation outcomes towards nationally determined contributions. . . . . shall apply robust accounting to ensure, inter alia, the avoidance of double counting,

Emission reductions resulting from the mechanism referred to in paragraph 4 of this Article 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.

These provisions, in combination with the progressive shift towards quantification of all emission sinks and sources, means that full national accounting for offset crediting must take place for both the recipient and the source of the units. For the recipient, there will be no change in their procedures in that the introduction and counting of outside units is already built in to the inventory processes underpinning the trading systems. But the source country will be required to make an equivalent reduction (also referred to as a “corresponding adjustment”) from their stated NDC, therefore tightening their contribution. This was a feature of the Joint Implementation (JI) mechanism under the Kyoto Protocol, but was not the required practice in the CDM.

The example shown in the box below illustrates this through a hypothetical case for a nature based transfer (NBT) from Kenya to Canada, utilizing the EMM as a means to acquire the necessary funding. The impact on the Kenya NDC implies a shift from a stated reduction of 30% from Business as Usual (BAU) in 2030, to some 37% below BAU. This ensures there is no double counting of the transferred amount and maintains the full integrity of the overall NDC approach such that the implied global cumulative emissions goal of the NDCs is maintained. However, Kenya will need to find further reductions in its economy as a result. One implication of this is that the price of carbon units may rise due to the additional demand that an overall emissions cap, even a notional one, places on the global economy.

Article 6 of the Paris Agreement offers great potential for carbon market development and emissions trading, therefore driving a lowest cost mitigation outcome and directing funding and financing to low emission technologies. But over time, it should also introduce an accounting rigor that has only featured in some quarters to date. This may well change the supply demand balance, leading to a more robust and enduring carbon market.

A new reality to come to terms with

dchone May 23, 2016

The first UNFCCC talks since the adoption of the Paris Agreement are now underway and the various delegations are getting down to the tough task of implementation. I was in Bonn on the opening day of the two week meeting, representing the International Emissions Trading Association (IETA) in a side event hosted by the Clean Development Mechanism (CDM) Executive Board (EB). The aim of the event was to draw on the learning from a decade of CDM operation and apply this experience to Article 6 of the Paris Agreement. This is the Article that provides a potential new foundation for carbon market development. I was there to present the IETA Article 6 Vision paper which I posted a story on recently.

The side event was packed out and many were standing in the corridor leading to the room; there is clearly considerable interest in this topic. Over the years the CDM has been a successful mechanism, resulting in nearly 8000 projects and some 1.7 billion Certified Emission Reduction (CER) units issued. Even at a €5-10 per CER (as it was in the earlier days of the EU ETS), this still represents a carbon price based financial injection of up to €10 billion into developing economies. The CDM spawned a small industry of project developers, assessors, MRV professionals and climate finance experts and clearly demonstrated that even a gentle application of the market can have a significant impact. Little wonder that there is such interest in the mitigation mechanism embedded in Article 6 and its potential to drive change.

However, the CDM (or a version of it) is unlikely to be repeated or replicated under Article 6, at least not under the terms that existed within the Kyoto Protocol. It was clear from the discussion during the side event that this new reality is going to take a while to hit home and settle in. The CDM became an important source of climate finance for developing countries, where the only real obligation on the part of the host country for a given project was to provide the necessary governance structure to ensure eventual issuance of the CERs. But that is no longer the case given the provisions of the Paris Agreement and Article 6 are now effectively the same for all countries.

Over time, Nationally Determined Contributions (NDC) will expand to cover all greenhouse gas in all economies. Every NDC, either specifically or notionally (for assessment and stocktake purposes) is linked to a quantitative carbon budget and there is an expectation from the Paris Agreement that these budgets will be delivered. While the Paris Agreement doesn’t say this in such stark terms, it is nevertheless implied. The whole approach that the UNFCCC used to assess the NDCs in their latest synthesis report, released on May 2nd, underpins this. Their aggregate analysis is summarized in carbon budget terms as follows;

The implementation of the communicated INDCs is estimated to result in aggregate global emission levels of 55.0 (51.4 to 57.3) Gt CO2 eq in 2025 and 56.2 (52.0 to 59.3) Gt CO2 eq in 2030. The global levels of emissions in 2025 and 2030 were calculated by adding the estimated aggregate emission levels resulting from the implementation of the communicated INDCs, that is 46.5 (44.3 to 48.9) Gt CO2 eq in 2025 and 48.0 (45.1 to 51.4) Gt CO2 eq in 2030, to the levels of emissions not covered by the INDCs. Global cumulative CO2 emissions after 2011 are expected to reach 533.1 (509.6 to 557.2) Gt CO2 in 2025 and 738.8 (703.6 to 770.9) Gt CO2 in 2030.

As I noted in my last post and drawing on Article 6.5 in the Paris Agreement, this means that the transfer of credits from a project across a national border (in the style of the CDM) will impact the national inventory reports of both parties. These transfers will then have to be executed in the style of Joint Implementation (JI) of the Kyoto Protocol, which effectively required an adjustment to the project host country’s national goal if the crediting unit was to be used by another Party to meet their goal.

I raised this issue as part of my presentation and the message was then amplified by a couple of people in the audience during the Q&A. But the response from some in the room was close to one of denial of this new reality, even though the Paris Agreement makes the need for such adjustment clear. The discussion almost drifted back into the old reality of developing countries not having goals and targets, but fortunately we didn’t land there. We didn’t resolve the issue either, which means that there are probably some tough discussions ahead as the negotiators get down to business.

A week later in Bonn and after many hours of discussions on Article 6 by the Parties, there has been some progress. At a side event on the second Monday also on Article 6 and also standing room only, I heard one central African delegate note that we had certainly left the world of the CDM and that perhaps we were somewhere between the constructions offered by CDM and JI of the Kyoto Protocol, albeit this would have to be interpreted to match the new bottom up global architecture of the Paris Agreement. I also heard another national delegate argue strongly that the new mechanism was not a sustainable development mechanism and should not be referenced as such, even if sustainable development was an important outcome of the implementation of the mechanism. Several panellists talked about quantification of NDCs as an important precursor to the avoidance of double counting.

The various concerns and issues that have been raised in these early discussion are very valid and the answers aren’t immediately obvious. Many developing countries have placed the need for finance as a condition on at least some portion of their mitigation contribution and in the past the CDM offered such finance. But if the reality of a new mechanism is a tighter national goal as a consequence of using it, there may be some push back. In the IETA paper one possible solution to this was proposed, namely the direct purchase of project units from the host country of the mitigation activity by multi-lateral funds. But this is unlikely to reach the necessary scale of mitigation envisaged by the NDCs, so other approaches will have to be developed. Interesting times ahead!

Update: The co-chairs in the UNFCCC discussions on Article 6 have released informal notes on ITMOs (here) and the proposed mechanism (here). These are a summary of points made in the initial discussions in Bonn.

A vision for Article 6 of the Paris Agreement

dchone May 13, 2016

Within the Paris Agreement sits Article 6, a carefully crafted set of provisions to foster, in the parlance of the UNFCCC and the Parties to the Agreement, cooperative approaches. This includes a provision for cross border transfer of mitigation outcomes and a mechanism to contribute to the mitigation of greenhouse gas emissions and support sustainable development. But for those outside the negotiating process (and hopefully those inside as well), this Article is seen as the foundation for carbon market development. There was a great deal of advocacy effort behind the Article, particularly from the International Emissions Trading Association (IETA) who argued strongly that such a construction within the Paris Agreement was essential to see accelerated adoption of government implemented carbon pricing; widely recognised as a critical policy instrument for managing carbon dioxide emissions.

The wording of Article 6 needs some deciphering and for those now assembling in Bonn to begin the process of implementation of the Paris Agreement, some steer from the private sector will hopefully be helpful. After all, if the provisions do enable the development and expansion of carbon markets then it will almost certainly be the private sector that is most deeply involved. To that end, IETA have now published a first thought piece on Article 6, setting out a vision for its implementation.

The IETA vision for Article 6 is built on the need for governments to implement carbon pricing, ideally through market based approaches such as cap-and-trade or baseline-and-credit. This starts with the internationally transferred mitigation outcomes (ITMO), described in 6.2 and 6.3. These transfers are effectively carbon market trades between governments or private entities operating through emission trading systems. One example is the link between California and Quebec, which effectively ties parts of the Nationally Determined Contributions (NDCs) of Canada and the United States together. Similarly the link between Norway and the EU ETS is doing the same for their respective NDCs. IETA argues that for clean and simple accounting and the avoidance of double counting, that the concept of exchange of carbon units, either notional or real, should be an underpinning feature of any ITMO. That means the basis for cooperative approaches is, for the most part, a market based one. For governments to access the economic benefits and cost effectiveness of a cooperative approach, they will need to implement carbon unit based emissions management systems within their economies.

IETA also recognises that not all governments may be ready or able to implement trading based systems, so its vision draws on another aspect of Article 6 to enable this. Paragraphs 6.4 (a) – (d) describe an emissions mitigation mechanism (which IETA have given the designation EMM). While some commentators are already arguing that this is a future version of the Clean Development Mechanism of the Kyoto Protocol (i.e. CDM 2.0), IETA makes the case for a much broader interpretation and use of this mechanism. Such implementation could see the EMM offering both universal carbon allowance and crediting units for those countries that choose to use them, facilitating trade between NDCs (i.e. ITMO), providing registry accounting and offering the prospect of carbon pricing in many economies.

The EMM could also be designed to establish sector baselines and issue sovereign credits for performance in excess of those baselines, which might then be purchased by external climate funds to channel investment. In this way it would function more like the CDM. But as IETA notes in its thought piece, the world in which crediting from one country acting as a direct offset in another is coming to an end. Under the CDM this was possible because the project host country had no quantified emissions management goal. As such, national accounting effectively took place on one side only, although the project itself had to have a credible baseline against which it operated. But as NDCs progressively expand to cover all national emissions (if they don’t then the Paris Agreement can’t claim to manage global emissions), paragraph 6.5 prevents such one sided accounting;

This means that the transfer of credits from a project across a national border (in the style of the CDM) will impact the national inventory reports of both parties. IETA argues that these transfers will then have to be executed in the style of Joint Implementation (JI) of the Kyoto Protocol, which effectively required an adjustment to the project host country’s national goal if the crediting unit was to be used by another Party to meet their goal.

The Paris Agreement introduces a very different world of international emissions trading to the one that exists today and has operated in recent years. The IETA paper concludes with a visualisation of how this might end up.

Developing Article 6

dchone February 22, 2016

Article 6 of the Paris Agreement contains a number of bolt holes for the development of market and non-market mechanisms to drive future mitigation.

Within these, paragraph 6.2 pertains to any linkage that might exist between Nationally Determined Contributions (NDCs), such as could occur between cap and trade systems residing in different countries. For example, Canada and the United States have such a linkage between the California and Quebec systems, with other states and provinces likely to join. Presumably when Canada presents the result of its NDC efforts to the UNFCCC at various stock takes, the transfer that has occurred between these two systems will need to be accounted for, with this paragraph leading to a clear set of modalities for the necessary accounting of the transfer. The longer term hope is that this paragraph provides additional impetus to such activities, catalysing both the use of such trading systems and the creation of links between them. This is an important step towards the formation of a globally traded carbon market.

Paragraph 6.4 is also a formative proposition, potentially containing within it the means to drive new investment and markets. It states;

A mechanism to contribute to the mitigation of greenhouse gas emissions and support sustainable development is hereby established under the authority and guidance of the Conference of the Parties serving as the meeting of the Parties to the Paris Agreement for use by Parties on a voluntary basis. It shall be supervised by a body designated by the Conference of the Parties serving as the meeting of the Parties to the Paris Agreement, and shall aim:

To promote the mitigation of greenhouse gas emissions while fostering sustainable development;
To incentivize and facilitate participation in the mitigation of greenhouse gas emissions by public and private entities authorized by a Party;
To contribute to the reduction of emission levels in the host Party, which will benefit from mitigation activities resulting in emission reductions that can also be used by another Party to fulfil its nationally determined contribution; and
To deliver an overall mitigation in global emissions.

Almost from the moment the gavel came down in Paris, commentators have been referring to this as the Sustainable Development Mechanism. This has become so embedded that when I returned to this part of the Agreement to write this post I was surprised that it isn’t actually called that. Rather, the mechanism is an EMM (Emissions Mitigation Mechanism) which supports sustainable development, not a sustainable development mechanism that happens to result in emissions reduction.

It is very early days, although Paragraph 6.7 gives the negotiators just this year to sort out the modalities and procedures of the mechanism. At a conference in London this month, a first discussion around Article 6 and particularly the mechanism within it took place. Although the meeting was more of a post-Paris stocktake, it offered an opportunity to get some thoughts and ideas onto the table.

One of the first of these was a presumption that the mechanism is simply the Clean Development Mechanism of the Paris Agreement, i.e. CDM 2.0. While it may eventually offer such a service, to limit it to this and no more may turn out to be very short sighted. In the first instance, the text above does not mention project activity or identify developing countries as the beneficiaries of the activities undertaken. This is in contrast to Article 12 of the Kyoto Protocol which clearly identified such a role for the CDM.

Rather, paragraph 6.4 is defined more broadly as a mechanism to contribute to the mitigation of greenhouse gases while fostering sustainable development. This means that it could have very wide scope and operate on many fronts or alternatively be specified quite narrowly but operate universally as a carbon trading unit. Other definitions or uses may also be considered.

Within a broad scope the mechanism could operate down to a single project, as was the case under the CDM, or become a crediting unit within a baseline system that operates across an entire NDC or within a sector covered by an NDC. Such a unit might be traded between systems, acting as the agent to link baseline-and-credit designs or even cap-and-trade designs. It could become a carbon reduction bought through a financing mechanism such as the Green Climate Fund, establishing that fund as a buyer of reductions as a means of driving mitigation activity. Other possibilities include linking it to technology demonstration or climate finance requirements.

The ambition embedded within the Paris Agreement is going to require change on a very large scale and at a very rapid pace; certainly much faster than could be envisaged through a project by project approach, as was the case with the CDM. While the CDM was very successful in what it did, the scale was hardly measurable against the size of the global energy system. This also argues against an early narrow use of Paragraph 6.4.

At this stage the possibilities are wide open and we need to keep them that way. In the months leading up to the Bonn intercessional meeting in late May, the opportunity exists to explore these options and think through the possible applications of a broadly defined mitigation mechanism. A rush to create CDM 2.0 would be a mistake, even if there is early recognition that the mechanism will need to fulfil this task as part of its overall definition.