2 September 2024
Forbes
Op-eds
Conversations about the role and integrity of carbon credits have increased lately, as governments and corporations around the world tackle the complex challenge of decarbonisation. Most of the focus has been on building demand for these credits. The supply side is over-looked. From my experience as a frontline player in this market, I envisage that even if the demand gets ramped up, a credits supply crunch is likely to become a significant bottleneck to the growth and effectiveness of the carbon market.
Three reasons have shaped my current view. One, there aren’t enough good quality credits that can meet the requirements of the only global compliance market – the Carbon Offsetting and Reduction Scheme for International Aviation (CORSIA). Forecasts by various agencies estimate that demand could be between seven and fourteen times greater than supply, depending on the actions airlines take to cut emissions, as well as the development of eligible carbon registries and projects.
The second reason is that despite a market surplus of over 500 million credits cumulatively, these fall under different parts of an overall market fragmented by vintage, jurisdictions, standards and increasingly as part of bilateral arrangements between countries under Article 6.2 of the Paris Agreement. As of August 2024, there are over 30 carbon credit standards. 86 bilateral agreements have been formed under Article 6 alone, covering 55 countries. Due to restrictions on interoperability of these markets, these credits are either not able to be used in markets where demand exceeds supply, or get double counted if they are eligible under multiple market fragments.
The third reason is around the type of projects that are being prioritised in the current formats of carbon markets. Renewable energy projects had for the last thirteen years accounted for more 40% of both issuances and retirements of credits in any given year in the voluntary markets. Given concerns around additionality, standard setting bodies are not issuing a high integrity Core Carbon Principles label to carbon credits based on current renewable energy methodologies. This excludes to a large extent credits coming into the market. In parrallel to this, nature-based solutions, the second biggest category driving the supply in carbon credits markets, has been rocked with scams and scandals, drying up new issuances and retirements from there as well. Consequently, in 2023, total issuances in the voluntary carbon markets crashed by 63% and retirements dropped by 75%, as compared to the year 2022. A dip in the confidence in voluntary carbon markets is evident.
So, what is the way forward? Carbon markets remain an important weapon in our arsenal in the fight against climate change. The most effective market structures for any commodity are often those where there is a single market, in which all players abide by similar rules, standards, and market determined pricing provides the economic signals for supply and demand. Several experts have envisaged a similar structure for international carbon markets. However, it is clear to me that the current landscape of international climate architecture makes it near impossible to have a single carbon market. Almost 50 countries have either implemented or are considering carbon taxes or domestic emissions trading schemes. International aviation and maritime bodies have announced their own as well, after years of negotiations. None of them are likely to roll back, nor is it desirable in the interest of reducing emissions at the earliest.
The next best alternative is made up of two parts – one, to get the best out of tools under Article 6 of the Paris Agreement and two, to unify the market as much as possible through aligning standards and making offsets usable and tradeable across the different schemes under Article 6 and those in different countries and regions. Currently, international policymakers are rightly focussing on the first part, by setting bilateral or multilateral frameworks under Articles 6.2 and 6.4.
Article 6.2 outlines the possibility of different actors, including governments and private sector companies, to bilaterally agree approaches for emission reduction and transfer of offsets, called Internationally Transferrable Mitigation Outcomes (ITMOs) in this case. Numerous agreements have already been reached, as highlighted above. But real transactions are in single digits, as their implementability depends on the establishment of clear regulatory and taxation structures at country levels. Two main issues must be addressed urgently. The first one is related to Corresponding Adjustments – meaning that countries allowing transfer of ITMOs from projects in their territory will not count them towards their own emission reductions. The second issue is a lack of clarity on government taxes and costs associated with the export of ITMOs. Only 14 countries, mostly in Africa, have so far clarified their stance on either or both of these issues. To attract the necessary capital, a much larger number of countries must set out approval processes for offsets, embedding them into national laws, and ensuring that these cannot be revoked later. They must also specify taxes and costs. This will provide confidence and legal security to developers and their financiers and enable them to make informed decisions.
Article 6.4 of the Paris Agreement provides for establishment of a more centralised international carbon market, operating under common rules and methodologies, with oversight of a UN Supervisory Body. Formally known as the Paris Agreement Crediting Mechanism, this could potentially take the form of a truly international carbon market over the longer term. However, this has been mired in negotiations. While progress has been made, including this year at the pre-COP meetings in Bonn, we rapidly need governments to move away from an approach of agreeing a full package to one where priority issues are agreed and the market is kicked off, while others get debated. The three priority issues to reach consensus on include (i) “methodologies” that define key ideas such as the “baseline” against which emission reductions can be credited (ii) the two mandatory tools - the sustainable development tool and the tool to assess the risk of carbon leakage, and (iii) the details of the independent grievance redressal mechanisms, to ensure that communities are not left unprotected against environmental and human rights violations. Once these are place, projects may be able to start issuing credits.
Just the setting up of these frameworks will not be enough. The issues in the carbon markets will only really be addressed by their unification and therefore this must be kick-started as well in all urgency. Unification will happen through alignment of standards and methodologies between different schemes and allowing usability and tradeability of credits generated in one scheme for compliance in another scheme. Significant progress has been made in defining the standards through the private sector and civil society initiatives like the Integrity Council for the Voluntary Carbon Market (ICVCM). We must build on these as much as possible. This must be aligned with the parallel efforts going on under the UNFCCC umbrella on methodologies. Finalising these standards will enable developers and buyers to focus their resources on projects that meet these criteria.
As the
international community prepares to gather for COP29 in Baku to finalise
negotiations on Article 6 and accelerate the development of global carbon
markets, it is essential to keep the challenge of supplying high-quality carbon
credits at the top of the agenda. While the growing demand for carbon credits is
encouraging, it is only through addressing regulatory, taxation, and
standardisation challenges—and by creating long-term demand incentives—that we
can scale up the supply of the high-quality credits needed to meet global
climate goals.
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