The Paris Agreement will lead to important changes in the way greenhouse gas emissions are accounted for and how they could be traded internationally. David Hone, Chief Climate Change Advisor with Royal Dutch Shell, looks at the implications of the Paris Agreement and concludes that it will probably lead to a more robust and enduring carbon market.
As COP 22 approaches and negotiators face the task of implementing the Paris Agreement, they will be required to interpret, expand on and operationalize the various Articles of the Paris text. One such piece is Article 6, which offers a framework that can support the establishment of a global carbon market. But the rules of that market may be very different to ones that have preceded it.
The design of the Kyoto Protocol resulted in a particular emissions accounting architecture that is a mixture of allowance allocation against a cap, combined with a provision for project based credits originating outside the cap (supplied by developing countries in the case of the Kyoto Protocol, i.e. non-Annex 1). These credits effectively raise the cap when they are imported into a covered system such as the EU ETS. Within the Kyoto Protocol, allowance allocation was handled through the Assigned Amount Unit against targets agreed by developed countries (Annex 1) and the most widespread crediting or offset system is the Clean Development Mechanism (CDM) which operates on a project by project basis in developing countries. This basic design has been translated into many jurisdictions, including locations such as California which is not covered by the Kyoto Protocol.
Although the first set of NDCs offered in the run-up to COP21 were varied in nature and in some cases only covered specific activities within the economy, over time they will likely converge in style
A feature of these systems is that the accounting normally handles the entities within the cap and the project outside the cap, but no attempt is made to account for the total greenhouse gas impact on the atmosphere or against a global goal to reduce overall greenhouse gas emissions. There is an implicit assumption that the sum of the various parts adds up such that the overall outcome is better than not having conducted the exercise at all. This happens because only a small percentage of the global economy sits under a cap, so there is no mechanism available to account for the total impact. This is one reason why some Parties challenged the appropriateness of the Kyoto Protocol itself.
A further issue related to the current structure is the macro accounting of the external credit. Projects vary in type, ranging from clearly measurable emission reductions (e.g. capturing land-fill methane) to notional reductions (e.g. a wind turbine is built, but the alternative might have been more coal). Particularly in the case of the latter example which is an energy mix question, there is normally no resolution between the local project and the overall energy mix direction of the host country. A key question is typically left unanswered; if the import of credits into a cap-and-trade system raises the cap, has there been an equivalent, albeit probably notional, decline elsewhere?
Direction of travel
But as the Paris Agreement starts to take hold, this will likely change. The Durban Platform, established at COP17 to create a global climate agreement applicable to all to replace the Kyotol Protocol, was designed to address these issues.
The Paris Agreement is built on the concept of Nationally Determined Contributions (NDC). These are set at national level and offer a direction of travel for a given economy in terms of its energy mix and/or greenhouse gas emissions. Although the first set of NDCs offered in the run-up to COP21 were varied in nature and in some cases only covered specific activities within the economy, over time they will likely converge in style and, for the Paris Agreement to deliver, must expand to cover all anthropogenic greenhouse gas sources.
Although nationally determined and always voluntary, the Agreement effectively establishes a cap, albeit notional in many cases, on national emissions in every country
The NDCs also lead us down another path – that of quantification. The first assessment of NDCs conducted by the UNFCCC in October 2015 and then refreshed in May 2016 required the quantification of all NDCs in terms of annual emissions and cumulative emissions through to 2030. This was necessary to establish an equivalent level of warming of the climate system, which is driven largely by the cumulative emissions of carbon dioxide over time. Without such an assessment, the UN cannot advise the Parties on progress towards the aim of the Paris Agreement.
The UNFCCC didn’t have a full emissions inventory on which to base this calculation, so they established one from the best data available. But Article 13 of the Paris Agreement introduces a transparency framework and calls on Parties to regularly provide;
- A national inventory report of anthropogenic emissions by sources and removals by sinks of greenhouse gases, prepared using good practice methodologies accepted by the Intergovernmental Panel on Climate Change and agreed upon by the Conference of the Parties serving as the meeting of the Parties to the Paris Agreement;
- Information necessary to track progress made in implementing and achieving its nationally determined contribution under Article 4.
The foundation for transparency is measurement and reporting, which further implies that emissions quantification is a foundation element of the Paris Agreement. Although nationally determined and always voluntary, the Agreement effectively establishes a cap, albeit notional in many cases, on national emissions in every country. The caps are also effectively declining over time, even for countries with emissions still rising as development drives industrialization.
Sinks and sources
Article 6 introduces the prospect of carbon unit trading through its internationally transferred mitigation outcomes (ITMO) and emissions mitigation mechanism (EMM). Text in paragraphs 6.2 and 6.5 is included to avoid any possibility of double counting;
. . . internationally transferred mitigation outcomes towards nationally determined contributions. . . . . shall apply robust accounting to ensure, inter alia, the avoidance of double counting,
Emission reductions resulting from the mechanism referred to in paragraph 4 of this Article shall not be used to demonstrate achievement of the host Party’s nationally determined contribution if used by another Party to demonstrate achievement of its nationally determined contribution.
These provisions, in combination with the progressive shift towards quantification of all emission sinks and sources, means that full national accounting for offset crediting must take place for both the recipient and the source of the units. For the recipient, there will be no change in their procedures in that the introduction and counting of outside units is already built in to the inventory processes underpinning the trading systems. But the source country will be required to make an equivalent reduction (also referred to as a “corresponding adjustment”) from their stated NDC, therefore tightening their contribution. This was a feature of the Joint Implementation (JI) mechanism under the Kyoto Protocol, but was not the required practice in the CDM.
Over time, the Paris Agreement should introduce an accounting rigor that has only featured in some quarters to date
The example shown in the box below illustrates this through a hypothetical case for a nature based transfer (NBT) from Kenya to Canada, utilizing the EMM as a means to acquire the necessary funding. The impact on the Kenya NDC implies a shift from a stated reduction of 30% from Business as Usual (BAU) in 2030, to some 37% below BAU. This ensures there is no double counting of the transferred amount and maintains the full integrity of the overall NDC approach such that the implied global cumulative emissions goal of the NDCs is maintained. However, Kenya will need to find further reductions in its economy as a result. One implication of this is that the price of carbon units may rise due to the additional demand that an overall emissions cap, even a notional one, places on the global economy.
Article 6 of the Paris Agreement offers great potential for carbon market development and emissions trading, therefore driving a lowest cost mitigation outcome and directing funding and financing to low emission technologies. But over time, it should also introduce an accounting rigor that has only featured in some quarters to date. This may well change the supply demand balance, leading to a more robust and enduring carbon market.
This article was first published on David Hone’s blog here and is republished here with permission.