[First published by Environmental Finance]

By Prajwal Baral

The Madrid Climate Conference (COP25) is nearly coming to an end, and there is little sign of agreement on an operational rulebook for Article 6 of the Paris Climate Agreement (PA), arguably one of the most important elements of the PA and the ongoing negotiations, says Prajwal Baral.

To put it simply, the key components of Article 6 relate to how sovereign nations will bilaterally trade on carbon emission reduction credits (Article 6.2), how the global carbon market will function, which includes both sovereign nations and the private sector (Article 6.4), and how non-market approaches such as applying tax to reduce emissions will work (Article 6.8). The first two Articles, which are the foundation of a market-based mechanism for global greenhouse gas (GHG) emissions reductions, have proven to be the major bones of contention among negotiating blocs.

Under Article 6.2, a country is allowed to meet its Nationally Determined Contribution (NDC) targets under the UN Framework Convention on Climate Change (UNFCCC) by trading with another country - emission reduction credits, technically called internationally transferred mitigation outcomes (ITMOs) under the PA. The ITMOs could also include added renewable energy capacity, restoration of forests, etc. that are more challenging to measure and trade. How accounting rules should be operationalised to avoid double counting of emissions reductions is the key sticking point here.

The double counting occurs when a country selling the carbon credits claims the underlying emissions reductions, and in the meantime, the country buying those credits also claims corresponding emissions reductions – effectively preventing the net reduction of global GHG emissions. Brazil, in particular, has pushed back against the prohibition of double counting for developing countries, at least for the first few years of the implementation of PA, because it wants its massive rainforest cover to benefit from both emissions reductions at home and sale of corresponding carbon credits abroad. A few other emerging economies are said to have been supporting Brazil's position indirectly. Most negotiating blocs are against double-counting, and in fact, it goes against the very ethos of the PA.

Similarly, under Article 6.4, the new market mechanism must deliver an "overall mitigation in global emissions" (OMGE) i.e. an overall cut in global emissions. In order to ensure that, some countries, particularly the vulnerable small island developing states have argued for a mandatory automatic cancellation of a fraction of Article 6.4 credits, which obviously is not agreeable to many countries.

Another major area of disagreement with regards to Article 6.4 is the transfer of Kyoto-era Clean Development Mechanism (CDM) credits to the new market mechanism under Article 6.4. The countries such as Brazil, India, and China, which already have a huge stockpile of Kyoto-era credits, have been advocating, either in public or behind closed doors, for a full transition of such credits to the new mechanism, while other negotiating blocs such as the EU are not agreeable to this because of the danger of such an approach flooding the market with cheap and weak carbon credits that have not achieved any emission reductions. Some countries have proposed a partial carryover of such pre-2020 Kyoto-era credits, in particular by imposing geographic (allowing credits only from least developed countries, for instance), or time-based (allowing credits generated after a certain period only) restrictions. Since most developing countries have no Kyoto-era credits, any carryover of those credits would benefit a select list of countries by allowing them to meet a part of their GHG emissions reduction targets without meaningfully reducing emissions – harming the environmental integrity of the PA.

In an ideal world, there would have been no need for a carbon market – the countries would reduce emissions corresponding to their NDC targets and keep ramping up their ambitions. In reality, this has not worked. Barring a few, most countries have not lived up to their NDC targets. The recently published Emissions Gap Report by the UN Environment Programme (UNEP) gave a stark warning that the world is already headed for a global temperature rise of 3.2°C, even if countries fulfill their commitments made under the PA. How, then, would a successful operationalisation of Article 6 be of any help?

We know that countries are not doing enough because the cost of emissions reduction is prohibitively high. What if such cost is lowered by some means? A study by the International Emissions Trading Association (IETA) and Carbon Pricing Leadership Coalition (CPLC) has revealed that Article 6 could reduce the cost of implementing NDCs by more than half, thus saving $250 billion a year by 2030. Alternatively, if these cost savings are invested in further climate mitigation action, this would facilitate additional emission reduction by 50% in 2030. As per the Emissions Gap Report, in order to achieve the "well below 2°C" goal outlined in the PA, countries need to ramp up their NDC ambitions threefold. The successful operationalisation of Article 6 seems to be the only financial markets-led hope for contributing to potentially enhanced ambitions by the countries.

This is not to say that Article 6 will save the planet. It alone will not. We need complementary policies and regulations to stimulate investment in innovative and cleaner technologies, including carbon removal strategies. We need tougher emissions and fuel standards for key polluting sectors. We need to remove institutional and market barriers that are preventing the mobilisation of green and sustainable finance at scale. We need targeted government policies that tilt the consumer preference from high-carbon to low-carbon consumption. The well-designed carbon market is only one piece of the puzzle, although a crucial one.

Prajwal Baral is a managing partner at investment consultancy Hornfels Group.