Uncertainty around the outcome of the 26th annual United Nations Climate Change Conference of the Parties has been holding back the launch of new carbon projects, with a potentially harmful impact on the development of voluntary carbon markets, several stakeholders told S&P Global Platts.

Concerns are emerging around the implementation of Article 6 of the Paris Agreement on climate change in particular, which will be one of the key points on the agenda for the conference in Glasgow, due to take place in November.

Article 6 will determine whether countries can use voluntary carbon markets to reach their net-zero emissions goals. It will also allow participating countries to set additional goals such as mitigating climate change and promoting sustainable development.

“The uncertainty around the Article 6 of the Paris Agreement is responsible for the current slowdown in supply,” a European carbon trader said. “We would have more projects implemented if there wasn’t a lack of clarity and understanding of what Article 6 will mean for countries and players.”

“The lack of internationally agreed rules as a basis increases the risk to investment in carbon markets generally,” said Hugh Salway, Head of Environmental Markets at The Gold Standard Foundation, in an emailed statement. “It prolongs uncertainty about the future of the Clean Development Mechanism and its projects.”

THREE PRIMARY ISSUES
There are three main unresolved issues that the Parties will be discussing at the 26th annual Conference of Parties.

The first is the future of the United Nations Clean Development Mechanism (CDM) and its projects, mentioned by Salway. The Parties will have to decide whether to allow carbon credits issued under the CDM as part of the Kyoto Protocol to be recognized also by the Paris Agreement.

Credits issued under the CDM are known as Certified Emission Reduction (CER) credits and currently represent some of the most competitive credits available on the market. Their competitive price is due to the old vintages held by these credits and the low-quality reputation deriving from this. The CDM scheme is the first scheme of its kind and CERs were issued as far back as 2006.

For some, the continuity of previous mechanism should be guaranteed to create a stable and inviting regulatory environment. According to others, many of the projects issuing CERs no longer comply with one of the core principles of voluntary markets, which is additionality, and should therefore be excluded from the current carbon finance space. Under the principle of additionality, to be eligible for credits issuance, a carbon project needs to prove that it would not be able to operate without the additional revenue generated from the sale of carbon credits.

A second unresolved issue is represented by the Share of Proceeds (SOP). Article 6 is expected to rule whether a portion of the proceeds coming from the trade of voluntary carbon credits should be destined to developing countries to help their mitigation and adaptation efforts. This portion of proceeds, which some opponents call tax, would go into a separate fund that will be used by developing countries to finance their mitigation efforts. Negotiations are underway to decide not only if a SOP should be set, but how large the percentage should be and how it will be managed.

The third and last issue is about deciding whether a percentage of carbon credits should be canceled any time a bundle of credits is purchased.

In other words, when a buyer purchases a bundle of carbon credits, a set percentage of those credits, for example 20%, is immediately canceled and no longer available to the buyer for its offsetting needs. This share of canceled credits could either be treated as a “climate bonus” to help reach even higher climate targets or, according to others, should be offered to host countries as a way to meet their mitigation obligation under the Paris Agreement.

According to Jeff Holmstead, a partner at the Bracewell legal firm and head of Bracewell’s Environmental Strategies Group, the second and third issues stem from the same question: “Should carbon credits be used simply to reach emission reduction targets at the lowest cost, or should it be used for other purposes — such as redistributing wealth across countries or attempting to go beyond the actual targets?”

“If we allow developing countries to benefit from a share of the proceeds coming from trading activities, or to keep some of the emission reduction credits purchased by buyers, we would help developing countries to reduce the cost of their mitigation efforts,” Holmstead said in an emailed statement. “But this would have an impact on voluntary carbon markets and on the environment because carbon finance will become less efficient and more expensive.”

THINGS WILL MOVE ON
While carbon markets are on the edge of their seat and are keen to get more clarity on the topic at hand, the general sentiment in the industry is that carbon credits will still play an important role on the journey to net-zero. The question just remains of what capacity.

“Regardless of the outcome of COP26, voluntary carbon markets will continue to grow,” said Robin Rix, Chief Policy and Markets Officer at Verra, in an emailed statement. “The world is witnessing an inexorable trend toward net-zero by 2050, and voluntary carbon markets are leading the way.”

Whether or not governments are able to reach an agreement in Glasgow this November, the voluntary market is likely to continue its growth, according to Salway.

“Bilateral trading arrangements between a select number of countries will also likely move forward, shown by the agreements Switzerland has already struck with Peru, Ghana and Thailand,” Salway said.