Resolving Article 6
Article 6 covers thorny issues around carbon markets and emissions trading; it is widely regarded as one of the most complex and least accessible concepts of the Paris Agreement. Subsequently at the COP25 talks in Madrid in 2019, Article 6 became ‘one of the highest profile casualties of the negotiations’. Varying disagreements on issues related to Article 6 since COP24 have led to retrenched negotiating positions, threatening potential progress at COP26. The president-designate of COP26, Alok Sharma, has reiterated the ‘UK’s objective of resolving long-standing divisions around Paris’ markets-governing Article 6 and agreeing a post-2020 rulebook for international emissions trading.’
Article 6 covers thorny issues around carbon markets and emissions trading; it is widely regarded as one of the most complex and least accessible concepts of the Paris Agreement.
Resolving disagreement on Article 6 at COP26 is important because it establishes the basis for the rules governing international carbon markets. Proponents argue that ‘linking’ international carbon markets – directly or indirectly connecting two or more carbon markets to create a larger market, ideally leading to efficiency gains – would allow countries seeking less expensive pathways to cut emissions, or countries that are unable to meet their NDC targets to purchase emissions reductions from other countries that have already cut emissions by more than their committed amounts. The creation of carbon pricing systems and opportunities to transfer units of reduction may mobilize large-scale financing towards effective mitigation techniques, both at the sector and project level. While some view Article 6 as a ‘make or break’ issue or essential for the future of carbon markets, others suggest that a lack of UN agreement on carbon markets to date has not hindered the development of existing approaches using bilateral agreements to trade carbon.
Currently, some 40 countries and 20 cities or states use carbon pricing mechanisms, covering around 13 per cent of global annual GHG emissions. There are two main types of carbon pricing: emissions trading systems (ETS) and carbon taxes. While emissions trading systems have proved popular, new and complementary forms of standards and regulations are also emerging. For instance, the EU intends to implement a carbon border adjustment mechanism (CBAM) – a cornerstone of the European Green Deal – which seeks to address ‘carbon leakage’ whereby companies relocate production to countries with less strict emissions standards. Policymakers in some countries are reluctant to adopt carbon taxes, preferring alternative approaches such as low-carbon subsidies or fee rebates for low-carbon practices. Compared with mandatory carbon markets covering specific industry sectors and GHGs, voluntary carbon markets may be accessed by any sector of the economy to offset emissions by purchasing credits, which has led to a boom in demand.
Article 6 has three operative paragraphs, two of which are about carbon markets and one is about non-market approaches to NDC implementation. These paragraphs broadly establish key concepts but have yet to be agreed upon. Article 6 instituted two international carbon markets through cooperative approaches (Articles 6.2 to 6.3) and the sustainable development mechanism, or SDM (Articles 6.4 to 6.7). Cooperation under Article 6 may help parties achieve their NDCs and enhance the ambition of their mitigation targets. Around 50 per cent of parties have indicated they intend to use international carbon markets in the post-2020 period.
The exchange of carbon units is a feature that underpins the internationally transferred mitigation outcomes (ITMOs) – a proxy term for transferred emissions reduction units for international emissions trading between parties to the Paris Agreement – to ensure appropriate accounting. To outline the concept, the Kyoto Protocol established two commitment periods for developed country participants – the first from 2008 to 2012, and the second from 2013 to 2020. During these periods, parties commit to specific reductions of GHG emissions. Parties with commitments under the Kyoto Protocol accepted targets to limit or reduce national emissions, expressed as levels of allowed emissions divided into ‘assigned amount units’ (AAUs). The protocol also established certified emissions reductions (CERs) as an emissions unit under the clean development mechanism (CDM) to help developing countries achieve sustainable development.
Currently, there is no legal basis to ‘carry over’ or transfer pre-2021 units from the Kyoto Protocol to count towards Paris Agreement targets, as the protocol and agreement are separate treaties. Within the protocol’s legal framework, underlying reductions or carryover of units beyond the 2013–20 commitment period are not permitted. Nor may AAUs or CERs be carried over into other commitment periods. Because the supply of CERs vastly exceeds demand, prices under Article 6 would be very low if CERs were allowed to transfer. Additionally, the combined quantity of existing CERs and AAUs is so great that it could undermine the current level of ambition under Paris, which is already failing to meet the agreement’s goals of holding warming below 1.5°C. In other words, if previous credits could be carried over, markets would be awash with them, which would drive down the impetus to undertake mitigation action.
Some countries are reluctant to ‘lose’ previous offsets, because to do so would mean reducing their commitments and potentially diluting the effectiveness of future mechanisms.
Yet some countries are reluctant to ‘lose’ previous offsets, because to do so would mean reducing their commitments and potentially diluting the effectiveness of future mechanisms. At COP25 in Madrid, China, India and Brazil pushed for Kyoto-era carbon credits to be allowed to transition under the Article 6.4 mechanism due to their large volume of issued and available CERs. Both the EU and climate-vulnerable countries have resisted the transition of Kyoto units, arguing that CERs would undermine ambition. According to an assessment by think-tank Climate Analytics, if Australia uses its surplus AAUs and China and Brazil use their CERs to meet domestic NDCs, this would reduce global ambition by 25 per cent. As a result, the projects issuing CERs would no longer be compliant with a core principle of voluntary markets: additionality, which requires any mitigation activity considered for a market-based mechanism to show that the corresponding emissions reductions would not have happened in the absence of the mechanism. For this reason, transferring units presents a problem as it may not represent actual emissions reductions and could compromise the global carbon market.
Related to the question of unit transfers is that of credits from the CDM transition. Importantly, Article 6.4 establishes the SDM that builds on and shares features with Kyoto mechanisms, particularly the CDM and joint implementation. The CDM operated under the Kyoto Protocol, which created legally binding emissions targets for six of the main GHGs in developed countries from 2008 to 2012. Now, however, all states have binding emissions targets, not just industrialized countries. This presents an issue as developing countries will have fewer credits to sell and should not be deprived of this less expensive mechanism for emissions reductions. Therefore, the SDM must both deliver an overall reduction in emissions and advance sustainable development within the broader 2030 sustainable development agenda, particularly the SDGs.
Operationalizing the share of proceeds
Another unresolved issue is around ‘share of proceeds’ (SOP) as defined by Article 6.6, which are taxes on carbon market mechanism activities. Operationalizing SOP would allocate a portion of proceeds from the trade of voluntary carbon credits to help developing countries in their adaptation and mitigation efforts. Under the CDM of the Kyoto Protocol, a monetary SOP was levied on credit issuance (an ‘administrative SOP’) and an in-kind SOP of 2 per cent on issued carbon credits was allocated to the Adaptation Fund (an ‘adaptation SOP’).
Now that the CDM will be replaced by the SDM, the question for COP26 negotiators is whether the SOP will be applied to the centralized SDM market or to all trading, including bilateral agreements. The Paris Agreement establishes SOP in Article 6.6 to be generated from activities undertaken through mechanisms in Article 6.4, the central UN mechanism to trade credits from emissions reductions generated by designated projects; it is silent regarding SOP for Article 6.2, which establishes a framework for cooperative market approaches. At Katowice, negotiations reached a stalemate between party alliances seeking to extend the SOP to Article 6.2 (including the Africa Group, the Arab Group, LDCs and like-minded developing countries), with other party alliances including the Umbrella Group and the EU opposing. Though parties agree on levying a monetary and in-kind SOP for Article 6.4, other issues remain, including: how to levy the SOP; the percentage of the tax; how to convert credits into revenues; how to utilize the proceeds; and the relative size of monetary versus in-kind SOP. These different options carry technical implications, some of which are best resolved at the UN level to avoid protracted and fragmented bilateral negotiations.
Resolving the ‘double counting’ issue
Accounting rules present a technical challenge considering the varied character of NDCs, which cover different time frames and may cover different sectors and GHGs across countries. Two Articles – 6.2 and 6.4 – pose immediate political roadblocks. The core question up for debate at COP26 is how to account for trade between countries that have different types of NDCs that vary in their emissions budget time frames. As countries exchange reductions, a single tonne of CO₂ could be ‘double counted’ by multiple entities, complicating target setting and reporting. Trading under Article 6.2 could then allow countries to meet a single-year target without actually cutting emissions, if the accounting is not conducted adequately. Additionally, tensions around double counting are focused on international carbon trading in Article 6.4 related to ‘corresponding adjustments’. However, increasing the volume of trade with private capital without reciprocal improvements in public policy risks undermining the negotiations. High-profile efforts, such as the Taskforce on Scaling Voluntary Carbon Markets, may ‘miss the mark’ by failing to deliver what carbon credits are meant to: reduce or remove CO₂ from the atmosphere. The current text includes several approaches for parties to choose from for their accounting mechanisms, and allows for further approaches to be put forward in the future.
Securing transparency
Closely tied to the issue of double counting is the question of transparency. Since the Paris Agreement does not have compliance and enforcement measures, transparency is a critical component for enabling accountability and trust, as established in Article 13. The language of transparency is also embedded in Article 6, which requires that parties ‘ensure environmental integrity and transparency, including in governance’. Now, the role of the COP process is to define what constitutes an acceptable way to show ‘robust accounting’ particularly to avoid double counting and to ensure accuracy in reporting on mitigation outcomes.
NDCs represent the fundamental basis of Paris Agreement commitments and NDC accounting is foundational for conducting the global stocktake. Therefore, the headline dispute to resolve at COP26 is regarding paragraph 77(d) under the transparency framework, which outlines an approach to avoid double counting under Article 6.2, referring to emissions but not to NDC accounting. This issue resulted in a deadlock at COP24, with some countries rejecting the idea that NDCs must be expressed as a ‘CO₂e’, or carbon dioxide equivalent, which they perceived as violating the bottom-up nature of the Paris Agreement that allows countries to choose their own NDC metrics. The way CO₂e is calculated is contested and has significant implications for certain sectors; without transparent guidelines, there is a risk of a carbon accounting system that does not lead to emissions reductions. Though parties agreed in the rulebook to adopt global warming potentials (GWP100) as the common metric to report CO₂e emissions, under the UNFCCC, developed and developing countries are treated differently in how methane is calculated: developed countries report emissions using GWP100 values from the IPCC’s Fourth Assessment Report (25 times the impact) while developing countries use values from the Second Assessment Report (21 times the impact). The assessments (21 times versus 25 times the impact) differ because GWP values are updated with new scientific estimates of the lifetime of the gas or changing atmospheric concentrations that influence the energy absorption of 1 additional tonne of gas relative to another. Consequently, there is a discrepancy in the metrics used for Paris reporting and for reporting under the UNFCCC. However, without a common unit of reporting, comparative assessments of ambition are more difficult to gauge. In the absence of comparable and complete information, assessing the adequacy of action and holding parties accountable under the current transparency framework is made more challenging.
Establishing common time frames
Establishing common time frames is considered by some as the ‘most underrated and misunderstood’ issue in climate talks as it has significant bearing on the underlying discussion on raising ambition and enhancing pledges. While climate action is continuous, time frames serve as checkpoints for when ambition may be increased; therefore, the absence of a common time frame for reporting and action could create an imbalance in pressure across parties. COP24 established that from 2031, NDCs should cover a ‘common time frame’ with the length of the time frame to be decided later. However, COP25 discussions did not result in agreement on time frames, failing to select a five-year, 10-year, or hybrid choice. The nature of the disagreement stems from some parties, including Russia and Japan, arguing that because NDCs are ‘nationally determined’, the time frame should be as well. Other parties, predominately vulnerable and low-income countries including Brazil, are concerned that the longer 10-year period risks locking in weak ambition by failing to respond more frequently to the availability of new green tech and the results of the global stocktake. More frequent reporting could also avoid a situation in which a country submits a one-time NDC pledging to meet net zero by 2050 but does not produce any implementation plan, including interim targets. Without common time frames, NDCs will remain difficult to compare and analyse as they will differ in scope, length and type of contribution. Common time frames would also improve the comparability and transparency of efforts for the global stocktake. The ministers from Switzerland and Rwanda are leading consultations in this area ahead of COP26.
Achieving a positive COP26 outcome
What can be achieved in Glasgow to advance the Paris Rulebook on the global stocktake, Article 6, common time frames, SOP from carbon trading, double counting, and transparency? COP26 can offer clarification on the global stocktake process, set to run from 2022–23, and on how and when the information is to be prepared and shared between countries. Agreement that the third phase of the stocktake will be completed in a timely manner to influence the 2025 NDCs, and a consensus on how the stocktake will be reported, are benchmarks for COP26.
Standout issues on Article 6 are critical, but it will be challenging to reach agreement. For negotiators at COP, achieving rapid decarbonization will demand broader policy action than carbon pricing and initiatives for international markets. Such policy considerations may include progressive emissions reductions from heavily emitting sectors in industry and transportation, as well as direct government regulation including performance standards, technology phase outs, and building codes. While advancing agreement on Article 6 provisions during intersessional meetings leading up to and at COP26 itself are crucial, wider support for complementary market and policy pathways to reduce emissions must also be developed simultaneously.
COP26 can offer clarification on the global stocktake process, set to run from 2022–23, and on how and when the information is to be prepared and shared between countries.
Yet, no deal on the rulebook could potentially be better than a bad deal, as pressure to reach consensus on a low-ambition deal would negatively impact the Paris Agreement. Not reaching an agreement on core issues would undermine the solidarity of the agreement, but not preclude domestic ambition. Failure to agree may also result in an accelerated role of ‘carbon clubs’ and market measures. Regardless of the outcome of COP26, carbon markets are already here. As the EU CBAM prepares to go into effect and other countries weigh similar policy measures, COP26 could usefully identify related opportunities that may incentivize alignment between production-based accounting and consumption-based accounting and avoid the current race to the bottom.
Charting a clear path forward to operationalize SOP could be an opportunity for COP26 to address gaps in ambition and significantly strengthen support for climate vulnerable countries, which otherwise may be excluded from the benefits of carbon markets due to their already low emissions. Levying both an ‘administrative’ SOP and ‘adaptation’ SOP with a mix of monetary fees and in-kind payment for Article 6.4, as proposed in the Katowice draft text, is a good option for negotiators at COP26 as it would reduce transaction costs, limit burdens on project developers, and create an option to benefit from higher market prices.
For common time frames, negotiators at COP26 should seek to agree upon a maximum five-year horizon for reporting in the post-2031 period. The discussion on time frames may also influence the course of debate on how to resolve the issue of double counting. Furthermore, common time frames would improve the transparency and comparability needed to conduct the collective global stocktake. If countries are allowed to choose their own time periods for reporting, essential functions of the multilateral climate regime will become extremely difficult. To address issues related to double counting, the San José Principles for High Ambition and Integrity in International Carbon Markets – a coalition formed in the run-up to COP25 supported by the EU and some Latin American and small nation and island states – may provide a starting point.
Progress on the transparency framework regarding NDC accounting is essential to allow meaningful assessments of ambition. A common reporting framework to assist transparency and generate an atmosphere of cooperation is a critical outcome for COP26 to achieve. A narrowed menu of options for accounting would constitute progress in this area.
