How will carbon markets help the Paris climate agreement?

The Paris Agreement marks a historic turning point for global co-operation to address climate change.

For the first time, 195 countries committed to take action to limit the global temperature rise to “well below 2C”. Through the final tense hours of the negotiations, it was doubtful whether the provisions on carbon markets would survive, given the staunch opposition to them by certain Latin American countries.

To the contrary, the agreement clearly establishes a new international carbon market mechanism, despite there being no reference to the words “market mechanism” or “carbon market” in the agreement.

So what does the Paris agreement say on carbon markets?

A new market mechanism

While the agreement doesn’t mention “carbon markets”, it allows parties to pursue “co-operative approaches” and voluntarily use “international transferred mitigation outcomes” to help meet their reduction targets, while ensuring that transparency and the environmental integrity of the regime is maintained.

Article 6 of the agreement establishes a new mechanism to “contribute to the mitigation of greenhouse gas emissions and support sustainable development”. The mechanism allows for the participation of both the public and private sectors, and, significantly, it aims to deliver an overall reduction in global emissions.

It will operate under the “authority and guidance” of a body to be designated by countries who have signed the agreement, and the rules governing its operation will be developed by the technical group under the UN climate body (the UNFCCC), with the view to being adopted in the first meeting of the Parties, after the agreement enters into force.

Countries must agree to robust accounting rules and must not double count emissions reductions. This means emissions reductions achieved in a country through the mechanism cannot be counted by that country towards their own emission reduction target if another country has bought those emissions reductions.

Learning from the past

This is not the first time a climate agreement has created a new mechanism. The 1997 Kyoto Protocol established the Clean Development Mechanism (CDM).

There are key differences between the CDM and the new mechanism. Notably, the new mechanism doesn’t contain any geographic restrictions. Emissions can be reduced in a developed or developing country and be bought by any other country.

This reflects the new dynamic in the Paris Agreement. There is no longer a formal distinction between the responsibility of developed and developing countries to cut. Indeed many developing countries have now made emissions reductions commitments.

The new mechanism is intended to go beyond a purely individual project-based offset mechanism like the CDM, and instead support new policies, activities and programs such as financial support to improve energy efficiency in the building sector of a country or to introduce and implement a renewable energy policy. It is also broad enough to support the linking of emissions trading schemes between parties.

Significantly, the new mechanism requires that it must result in an overall reduction in global emissions, rather than simply offsetting emissions. This was a contentious issue in the negotiations. There is no such requirement in the CDM. Time will tell how countries will implement the mechanism to ensure that this requirement is met.

What now for international carbon markets?

The call for a global carbon price was a central theme in the sidelines of the meeting, with business making loud calls for countries to introduce a carbon price and World Bank group president Jim Yong Kim declaring it was important to get momentum behind carbon pricing.

While much of the detail of the new mechanism is yet to be fleshed out, the framework sends a long-term signal to investors that all countries support the emergence of a global carbon market. It is inevitable that post 2020, we will see a range of inter-linked carbon markets develop.

International units or offsets are an increasingly controversial issue in the global fight against climate change. There is a risk that by using foreign emissions reductions countries could delay the task of decarbonising their own economies.

It is clear that to meet the 2℃ or better goal, all major economies will need to make serious domestic emissions reduction cuts by implementing strong domestic policies that will transition away from reliance on fossil fuels. Offsets can play an important role in scaling up ambition and allowing businesses to meet their commitments at the least cost. But the country using them must simultaneously bring down their own domestic emissions.

Public finance alone cannot transition developing countries away from fossil fuels. The mobilisation of private sector finance through carbon markets could play an essential role in scaling up low emissions development, provided that clear accounting and monitoring, reporting and verification rules are established.

This is particularly the case if the new mechanism goes beyond single projects and supports the implementation of new policies and programs.

One of the key risks is that that supply of credits might initially outstrip demand, as only a handful of the countries that support using markets to meet their climate pledges are likely to be buyers, such as Canada, Japan, New Zealand, South Korea, Switzerland, Norway. Australia has until now ruled out using international credits, but after the conference environment minister Greg Hunt stated that Australia “probably will” use international credits to meet emissions reduction targets.

Carbon markets in Australia

As the Paris summit progressed, Australia softened its position on carbon markets.

In the second week, it signed a declaration developed by New Zealand to bolster support for carbon markets and commit to develop rules to govern a post-2020 carbon market.

Foreign Affairs Minister Julie Bishop recognised the importance of carbon markets. And at the conference, Greg Hunt reportedly referred to the Safeguard Mechanism as a “baseline and credit” scheme.

Under the agreement national emissions reductions targets will be reviewed and ramped up, beginning in 2018. Australia should now consider how carbon markets could assist it to increase its existing 2030 target, in order to make a responsible contribution to stabilising temperatures at 2℃ or below.