After COP28: what next for international carbon markets?

Introduction 

Even as COPs go, the annual climate summit in Dubai brought high drama and painful compromise. At a summit level, there were some important steps forward. The Loss and Damage Fund announced on Day 1 was a considerable achievement, marking the first time a fund has been set up to address the impacts of climate change in developing countries. And while the Global Stocktake agreed for the first time to transition from fossil fuels, countries could not agree to an unequivocal statement to phase out fossil fuels for good. 

For carbon markets, the failure to progress Article 6 is extremely disappointing. It was also a surprise, especially considering that the Supervisory Body, a group made up of the country negotiators themselves, had already agreed on some of the main proposals up for discussion at the conference. 

What happened in the negotiating room on Article 6? 

Negotiations for both Article 6.2, the bilateral carbon market, and 6.4, the UN-supervised marketplace, quickly came to a standstill. The list of topics that could not be agreed is long.

On Article 6.2, disagreements arose over how to define cooperative approaches, specifically how to ensure that trading of credits would meet higher thresholds for carbon quality. There appeared to be two broad camps - one calling for clearer definitions and standards to ensure quality, the other arguing that reporting and review mechanisms would be better placed to govern standards. 

Other issues included the confidentiality of information, or improving levels of transparency, and the revocation of ITMOs, a sticking point that many thought would deter private investment and prevent the market from scaling. Moreover, the proposed text contained little detail on review and reporting processes and there are continued concerns over a lack of oversight for the mechanisms.

For Article 6.4, there were a range of topics up for debate. A committee advising on the development of the market proposed two texts for Article 6.4 setting out guidance on how to set ambitious methodologies and how to govern removal credits, including the risk of reversal of decarbonisation projects. The debates we have seen pervading the VCM over the last year came to the forefront in these discussions. Many countries were concerned the texts did not contain sufficient safeguards to ensure environmental integrity. Whereas other parties thought the proposals unfairly increased complexity and costs of delivering projects. 

In addition to this, old arguments re-emerged with greater intensity. This included debate of the types of projects allowed, such as emissions avoidance and conservation enhancement. The topic of revocation in Article 6.4 was very divisive, and repeated drafts were unable to satisfy opposing views on the topic. 

Underlying these debates was the increased profile Article 6 has on the political agenda. Countries are increasingly looking to integrate carbon credits as a tool within domestic policy instruments and this is raising the stakes of the Article 6 agreement - what qualifies under article 6 is becoming an increasingly contentious debate. 

The final draft texts produced contained numerous problematic clauses and could have risked the success of the international carbon market itself. Negotiators are said to have preferred refusing the texts at this point then ending up with the adoption of problematic and weak rules for both Article 6.2 and 6.4 mechanisms. 

So what next?

Although a new agreement stalled, the need to rapidly scale finance has never been so important. The final text agreed for the Global Stocktake emphasises the need to continue to advance international carbon markets with specific reference to the urgent need for the accelerated implementation of Article 6.¹

Article 6.2 and 6.4 texts will be brought back to the negotiating table at Baku at COP29. However, the lack of agreement at COP28 does not mean countries are back to square one. The text agreed at COP26 in Glasgow is still in place and allows for the operationalisation of Article 6.2 - which is already underway as evident from numerous new announcements at COP this year. However, exactly how the trading of ITMOs will develop under Article 6.2 is still largely unknown with many aspects left to the countries themselves to decide upon. 

Importantly, while 6.2 agreements to date have focused on country to country trade, the framework is expected to accommodate other mitigation approaches such as compliance mechanisms, CORSIA and the involvement of the private sector. Delay on the 6.4 marketplace should not mean we hold up the important progress already underway.  

For the bilateral market to scale, it will need to look towards the lessons learned from the last two decades of carbon markets, including the Clean Development Mechanism, the first UN carbon market. These lessons have led to innovations across the voluntary carbon market that are increasing transparency and integrity. This includes integrity initiatives, such as the ICVCM and VCMI, ongoing improvements in setting methodologies by standards bodies, and the use of carbon credit ratings. 

By design, the bar for what can be considered a cooperative approach under 6.2 is low - this helps to foster innovation, speed up project development and respects the sovereignty of countries involved. But in the absence of clear standards, it requires impartial, independent oversight to build trust. Carbon ratings have a key role to play in this space and could mean the difference between a race to the bottom and race to the top of carbon quality. 

Early adopters in the 6.2 market will also play a key role. The work of Switzerland, Singapore and other players will be important in shaping what is deemed as a high quality credit and good practice for trading of internationally transferred mitigation outcomes (ITMOs)

For Article 6.4, negotiators will go back to the drawing board. Much of the work done by the Supervisory Body is still valuable - the issues of raising thresholds and increased scrutiny of how factors such as leakage and permanence are minimised remains important. A lot can happen in a year. 

Nevertheless the sheer number of issues that were difficult to overcome at COP will no doubt resurface the topic of carbon clubs - cooperation between smaller groups of countries - and how like minded countries can advance market mechanisms separately.

What are the implications for the VCM?

We saw strong political support of carbon markets during finance day at COP28. With key figures from the US, UK, Singapore, Indonesia and Nigeria speaking out in support of the VCM and welcoming the emergence of integrity initiatives such as the ICVCM and VCMI. 

Political support is important. There is increasing recognition that private actors will provide the capabilities to support the development of both UN and compliance markets. As national governments look to introduce carbon credits as part of their climate strategy, their endorsement is a key first step to leveraging credits as a tool to accelerate the path to net zero. 

Ongoing innovation in the sector will build on this. The announcement of alignment between standards such as Gold Standard, Verra and Climate Action Reserve and the establishment of an end-to-end integrity framework will bring much needed certainty and consistency to the VCM. 

One issue on which all parties were aligned was the urgency of the climate challenge and the shortage of finance to meet the 2 degrees target. Article 6 remains the single global tool we have to systematically reduce the cost of decarbonisation and accelerate the path to net zero. Even as diplomacy stutters in Dubai, this doesn’t change. 

References:

¹ Paragraph 31