Four Ways Development Agencies Can Advance Carbon Markets

Tetra Tech’s Rodrigo Chaparro, senior climate advisor, looks at how international development agencies can advance carbon markets.

This is the third in a three-part series exploring how Article 6 of the Paris Agreement can spur the clean energy transition.

With the 2022 United Nations Climate Change Conference (COP27) fast approaching, attention is on individual countries who are expected to show how they will, “through legislation, policies and programs, and throughout all jurisdictions and sectors,” begin to implement the Paris Agreement.

The new market-based instruments approved by Article 6 encourage international carbon trading, long seen as the likeliest way to incentivize global climate action. The International Emissions Trading Association estimates that Article 6 could reduce the total cost of implementing Nationally Determined Contributions (NDCs) by more than half and facilitate removing 50 percent more emissions at no additional cost.

Although the potential benefits of cooperation are clearly huge, how to cooperate remains a big question.

“The new market-based instruments approved by Article 6 encourage international carbon trading. Successful implementation will require funding, technical advice, and sustained support from development agencies.”

Successful implementation of Article 6 rests on the capacity of countries to address four key issues, which will require funding, technical advice, and sustained support from international development agencies.

Key Issue 1—Domestic Action vs. International Transfers

First it is critical to classify the country’s target mitigation efforts:

1. Actions a country commits to implement on its own (e.g., unconditional targets such as reduction of fuel subsidies)
2. Actions that need international financial support (e.g., conditional targets such as aggressive renewable energy goals)
3. Actions that go beyond the country’s NDC commitments due to financial or local capacity constraints or national priorities (e.g., introduction of emerging technologies such as carbon capture and storage)

Only projects in categories 2 and 3 are eligible for international markets, where emission reductions are transferred from one country to another. International trading must supplement domestic action. Therefore each country needs to define which mitigation efforts it will implement on its own and which ones will be eligible for international trading. This requires a careful review of the country’s NDC targets, a cost-benefit analysis, and policy decisions on which sectors—such as transportation, electricity production, agriculture, forestry—and which greenhouse gases (GHGs)—such as carbon dioxide, methane, hydrochlorofluorocarbons—are eligible for international markets.

Key Issue 2—The Corresponding Adjustment

Every country must address a long-standing stumbling block in Article 6 negotiations: the issue of double counting.

The 2021 United Nations Climate Change Conference (COP26) established an accounting mechanism known as the “corresponding adjustment” to ensure that only one country counts each emission reduction. If a country authorizes a transfer of emissions under Article 6, the mitigating country subtracts the emission reduction from its GHG balance, while the acquiring country adds the emission reduction to its GHG results. The corresponding adjustments are a means to ensure the integrity of carbon markets and the complementary relationship of voluntary carbon markets with the decarbonization efforts under the Paris Agreement.

Determining when the corresponding adjustment is necessary will require a bit more fine-tuning. Once a country clarifies the sectors and gases covered under Article 6, it will need to specify if a corresponding adjustment is required when a credit is transferred to another country. If the credits are authorized by the host country, a formal process to transfer and apply the corresponding adjustments between the two countries will be required. This will involve some technical and legal work as not all countries have the same type of NDC targets.

Some countries have established targets based on a percentage reduction compared to a base year, while others have a carbon budget or a target emission level for a specific year. Countries will need to define how to manage the accounting when the trade involves non-equivalent frameworks.

Credits not authorized by the host country do not require a corresponding adjustment. However, they still may be eligible for international trading under the voluntary carbon markets.

Key Issue 3—Monitoring, Reporting, and Verification

Tracking emission reduction credits and preventing double counting will require a robust national emissions reporting system that is transparent and secure. This national reporting system should record data that is standardized internationally for ease of auditing to accommodate bilateral (Cooperative Approach) and multilateral (Sustainable Development Mechanism) approaches. Additionally if information from different countries and registry systems is reflected in a common system, there will be less risk of the same carbon credit being sold twice.

The ongoing development of national carbon markets in various countries adds to the complexity, though it also can contribute to transparency and expedite implementation. All this points to the need for significant monitoring, reporting, and verification (MRV) and administration capacity.

Countries will need to establish guidelines for evaluating carbon credits and deciding which can be sold, how they should be priced, and how the country will report on them. The use of high-quality credits is crucial to the realization of net-zero emissions. High-quality credits are based on sound accounting principles and meet additionality criteria, meaning they represent emission reductions that would not have occurred otherwise.

The system for monitoring and evaluation of credits needs to be constructed so that it works across sectors and incorporates all programs and policies related to achievement of the NDCs. A proper MRV system should track not only GHG and short-lived climate pollutants but also mitigation activities and climate finance.

Digitalization of MRV processes will reduce the time, and consequently the transaction costs, required to generate emission reduction trades. This will help ensure that more of the carbon revenues flow toward mitigation projects. It also will enable an automated process of following every traded credit from its generation all the way to its transaction.

Key Issue 4—Regulatory and Administrative Frameworks

Carbon credits subject to a corresponding adjustment will require a formal endorsement by governments. This is required not only because those transfers will affect the NDC targets but also because they will be subject to international trade rules. Participating parties will need to establish robust administrative processes to guarantee the transparency of the approval protocols for specific projects. They also will need to establish the legal validity of final transactions and the proper and timely reporting to the United Nations Framework Convention on Climate Change of any changes in the NDCs. This implies the creation of new institutions or the appointment of committees with enough authority to endorse those transactions.

Japan’s Joint Crediting Mechanism (JCM) and the Kyoto Protocol’s Clean Development Mechanism (CDM) provide examples of such regulatory bodies. Japan’s JCM uses bilateral committees and the Kyoto Protocol’s CDM requires approval from a national designated authority. Successful participation of countries and companies in international markets—and the achievement of crucial NDCs—hinges on the development of regulatory and administrative frameworks within countries and globally.

“Successful participation in international carbon markets—and the achievement of crucial NDCs—hinges on the development of national and international regulatory and administrative frameworks.”

How can Tetra Tech collaborate with international development agencies to support countries’ participation in carbon markets?

Tetra Tech has extensive experience providing governments with comprehensive programmatic support to develop and implement their low-carbon development strategies and associated NDCs. Since the outset of the carbon market in the early 2000s, we have been deploying comprehensive low-carbon programs around the globe. Our approach is to accelerate the implementation of clean technologies and policies to achieve net-zero emissions. We also aim to enhance the resilience of systems by maximizing the potential benefits of carbon credits.

Our climate change services include:

• Formulating national and regional decarbonization strategies and plans
• Developing policy, regulatory, and pricing frameworks that benefit from carbon markets
• Managing the transition to competitive markets
• Assessing GHG mitigation options
• Supporting monitoring, reporting, and verification
• Enhancing institutional infrastructure for the deployment of efficient carbon markets
• Establishing public-private partnerships

Read more from Rodrigo about how Article 6 of the Paris Agreement can spur the clean energy transition:

• Using Carbon Markets to Fuel the Clean Energy Transition
• Three New Business Models to Achieve Carbon-Reduction Goals

Special thanks to Juan Pedro Searle Solar, chief of climate change unit and senior advisor for Article 6 negotiations under the 2019 United Nations Climate Change Conference (COP25) Presidency Team, Ministry of Energy, Chile, for his review and feedback