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India’s position on Article 6 at COP25: Explained

At this year’s COP25, much of the conversation was on Article 6 of the Paris Agreement which calls on countries to set up voluntary market and non-market mechanisms that promotes sustainable development. In response, parties to the Paris Agreement have set out to form an international carbon trading market which incentivizes countries to mitigate GHG emissions. COP 25 was the platform provided to negotiators to iron out the technical details of an international carbon market which had continued to be in a state of limbo since COP 24 at Katowice.

Establishing carbon market under Article 6 of the Paris Agreement

To encourage further cooperation amongst all parties, the current discussion has been around setting up the next iteration of a global carbon market, referred to as the ‘Sustainable Development Mechanism’ or SDM. 96 parties out of the 185 who have submitted NDCs have stated that they are planning to use domestic carbon pricing methods to meet their NDCs.

Fig. 1 Shows parties who have agreed to implement carbon pricing in their NDCs. Source: State and Trends of Carbon Pricing, World Bank, 2019

 In addition to supporting sustainable development, Article 6 calls for “environmental integrity and transparency” under the new mechanism to ensure it mutually benefits all parties in the long-run. Regarded as one of the most complex articles in the Paris Agreement, building an international carbon market that both developed and developing countries can agree and therefore comply to, has proven to be a big task.

Background on Clean Development Mechanism (CDM) 

The CDM, under the Kyoto Protocol, is the only large scale carbon offset market in operation. The CDM was setup as a carbon finance mechanism that developed countries (referred to as Annex I countries) use to offset their emissions by buying credits, otherwise known as Certified Emission Reductions (CERs), generated from UNFCCC certified green projects in developing countries (referred to as Annex II countries). This benefits developed countries as the cost of abatement is cheaper than it would be if credits were bought from domestic projects. This also provides developing countries impetus to set up sustainable projects whilst increasing the number of certified green projects.

Developing countries push for unsold CERs from CDM to be valid under Article 6

Questions remain unanswered about how the market should be homogenized since countries have a wide variety of targets under their NDCs. A total of 350 million credits (under both voluntary and mandatory CDM projects) were issued under all projects in India. Out of which, there are a high number of unsold CERs as a result of low demand which resulted the price to plummet. Presently, CERs futures contracts are trading at €25 cents/tCO2e.

Fig. 2 Price of CERs futures contracts for the month of Nov, Dec and Jan. Source: International Continental Exchange

Undervalued credits not only make it much cheaper for polluters to buy off offset credits (meaning the price to pollute becomes much cheaper); it also discourages project installers to implement newer projects that can be eligible for CERs because their returns are significantly lower. At COP 25, India along with other developing countries such as Brazil and China pushed for the stance that credits generated under CDM should be transferred to the new carbon market under Article 6 as these are projects that have been validated by UNFCCC. If sold, India has the potential to earn around INR 50 billion from the unsold carbon offset credits.

Issuance of carbon offset credits

Part of the reason as to why there is a push from countries to use the outstanding credits is that approval process of carbon offset credits is a strict process. Committees have to ensure that it can mitigate long-term GHG emissions which can be measured and only then can a project generate tradable and saleable credits. To qualify for CDM all projects have to ensure that they are socially, environmentally, economically and technologically beneficial amongst other requirements. Allowing existing CERs to be traded on the market would mean a ready-made supply of saleable credits in the market. Developing countries understandably want to reinstate a continued stream of finance through these projects. India also wants adequate incentives in place to increase voluntary private sector participation in addition to government-led projects.

Developed countries want a fresh start under SDM

The EU who were arguing against adapting the same say that a brand new carbon market should exclude CDM credits because an excess supply of credits without existing demand can devalue the credits. This will follow the same pattern that the CDM market did, undervaluing the credits significantly defeating the purpose of an effective carbon market. The new mechanism also has to implement safeguards to make sure credits are not being double counted by both the host country and country buying the credits to meet their NDCs. While India has supported the argument for double counting, countries like Australia had been vocal against it which stalled the negotiations even further.

Factors to consider during the next steps

Offsets are one variation of a market mechanism. Protestors at the COP25 pointed out that carbon offset projects have a weak record on human rights, discouraging implementation of any carbon market. However, there are other mechanisms that can be put in place to achieve similar GHG reductions. In order to not repeat what happened under CDM, the impending carbon market has to make sure that there are other compliance mechanisms in place like carbon allowances which in theory would result in the same GHG emissions reduction, while setting up another method for the polluter to pay. As with any carbon market, there has to be regulatory backstops in place like price controls and reserve tiers to regulate supply of credits over a compliance period.      

Negotiators should take heed of learnings from CDM while looking beyond 2020

There were a number of learnings from the CDM market that can be revisited to make sure post-2020 carbon market is stringent in order for there to be significant decline in GHG emissions:

  1. Regulators have to make sure credits under SDM are priced accurately. The World Bank calls on countries to price carbon at US$ 40-80/tCO2 by 2020 and US$ 50-100/tCO2 by 2030 which would be consistent with achieving the 1.5 degree goal
  2. An increase in the price floor of carbon offset credits by a certain percentage in a compliance period, in essence, increasing the price of pollution
  3. A limit of on how many credits a party can buy  in a year to ensure that mitigation measures are put in place to meet the remainder of their targets under NDCs
  4. Making sure a wide range of sectoral coverage is achieved through this, since this can generate more credits and mitigation measures across those sectors

From the latest series of negotiations it is evident that there is political unwillingness to a certain extent in setting up a carbon market. Negotiations also slowed down as a result of countries not being able to agree on an accounting mechanism which is a vital cog in a carbon market of this scale. Participants expressed their relief, in part, because of the impasse as there was a resounding sentiment that ‘no deal is better than a bad deal’. Perhaps by COP 26, parties will be prepared to form a transparent and equitable market.