15 December 2021

The Voluntary Carbon Market and Article 6: Paths to Convergence?

Oli Parker

Carbon Credit Analyst

Nandita Lal

Carbon Markets Consultant


BeZero’s Carbon Credit Analyst, Oli Parker, and Carbon Markets Consultant Nadita Lal, build upon our earlier analysis to unpack the agreement on Article 6 which emerged from COP26, focusing specifically on its implications for the voluntary carbon market (VCM).

  • The advent of cross-sector bilateral offset transactions provides a boost for the VCM’s credibility, as both prices and demand continue to soar.

  • Uncertainty remains regarding the purposes for which non-adjusted credits can be used, with key market players adopting divergent stances.

  • Assessing offset quality becomes more difficult in a world of corresponding adjustments. This is where BeZero Carbon Markets comes in.

The dawning of a new day

Following two failed attempts to reach an agreement on Article 6 at conferences in Katowice and then Madrid, negotiators at COP26 in Glasgow were finally able to clarify the rules that guide international carbon markets.

Article 6.4 and 6.2 contain the key provisions. As a successor to the Kyoto Protocol’s Clean Development Mechanism (CDM), the text’s fourth passage establishes a centralised carbon market mechanism regulated by the United Nations Framework Convention on Climate Change (UNFCCC).

This signifies a clean slate for climate mitigation. With a more predictable market-based approach built on more stable foundations, countries can now use carbon credits to help meet their Nationally Determined Contributions (NDCs) via the agency of government-to-government cooperation.

Meanwhile, the agreement’s second paragraph stipulates that when an Internationally Traded Mitigation Outcome (ITMO) is issued under the new crediting mechanism and sold abroad, as opposed to being used by the host country, then a corresponding adjustment can be made. The choice is left to the host country.

Corresponding adjustments require host countries to deliver a guarantee that transferred credits won’t be used against their own NDCs, which they will declare in their Biennial Transparency Reports (BTRs) from 2024 at the latest¹. This process aims to ensure that carbon benefits can only be claimed once — either by the host country, or by the purchaser.

A byproduct of these developments is the recalibration of carbon credits from global to national assets. Governments now exercise the authority to pick and choose which, if any, domestic offset projects they are willing to export for use against other countries’ NDCs, and which they want to keep for themselves. This has seen carbon shift from being a freely tradable international commodity, to an asset inseparable from national emissions targets and geographical boundaries.

As for private engagement with carbon trading, the Voluntary Carbon Market (VCM) has experienced rapid growth in recent years and reached an all-time peak market value of $7bn in 2021². For context, the 300 Mn tCO₂e traded on the VCM so far this year roughly equals the entire volume of Spain’s annual greenhouse gas emissions³. However, to date widespread skepticism has been levied at the VCM’s integrity, and fundamentally, its utility in tackling the climate crisis.

Although the newly agreed rules around Article 6 still leave many nuances unresolved, the key takeaway is that carbon markets are here to stay; and with more fine-tuning will play a vital role in enabling effective climate action, at both governmental and corporate levels.

A reputational triumph

A significant win for the VCM is its implicit inclusion with regards to correspondingly adjusted credits under Article 6.

Similarly, Article 6.4 allows for the transfer of authorised emission reductions for international mitigation purposes. This may include the VCM and schemes like the Carbon Offsetting and Reduction Scheme for International Aviation (CORSIA) (see Chart 1)⁴.

Despite the semantic ambiguities, these developments are understood to enable countries and private companies to engage in bilateral offset transactions, allowing credits backed by corresponding adjustments to be generated and traded in the VCM. Given that investors were often deterred from participating by the absence of mechanisms to prevent double counting previous to COP26, this is welcomed by players in the market and ultimately affords the VCM a greater degree of credibility moving forward⁵.

By allowing governments to authorise carbon credits for use by corporations, the new rule reduces the chances of credits being used by both the host country and the purchasing company. While only time will tell how far these transactions contribute to an active and liquid market, their endorsement serves to improve the integrity of voluntary credits and thus raise their investment potential.

Up, up and away

So tangible is this reputational boost that it has already been reflected in offset prices and demand. As traders bet on the emerging potency of carbon markets off the back of the Glasgow conference, soaring carbon prices reached an all-time high of €89 per tonne within the European Union Emissions Trading System (EU ETS) as of 8th December, more than doubling February 2021 levels⁶.

And this is just the beginning. With the advent of corresponding adjustments giving governments first refusal on offset projects, state actors are expected to claim the cheapest available credits to use against their NDCs. Through this process, the market will be subjected to mounting buying pressure and both itself and project developers will be driven up the cost curve, with this high-growth trend looking set to continue in the long-term.

Project developers will face increased uncertainty and political risk on account of some credits being backed by corresponding adjustments, and some not; leading investors to demand high risk premiums for participation and thus sustaining high carbon prices.

Another driver of higher prices will be the time it takes to create the infrastructure for new markets and adapt to its mechanisms. Since today’s backdrop is one of subdued supply of new projects in the short-term amidst rising demand, the race is on for project developers to catch up⁷.

The result of such swelling prices and demand, in all likelihood, is improved competitiveness for previously unaffordable offset projects, and seemingly boundless expansion. Regimes which impose corresponding adjustments are also likely to see continued upward price pressures as demand grows, such as CORSIA. So far, so good for stakeholders in the VCM.

A double-edged market

Perhaps unsurprisingly, however, it’s not all sunshine and rainbows with much remaining unexplained. As already touched upon, the complex world of Article 6 allows VCM participants to choose whether they need corresponding adjustments for their credits. This will almost certainly result in the establishment of a fragmented market, whereby adjusted credits are regarded as offering greater climate benefits and thus wield a higher premium than non-adjusted credits⁸.

It’s worth noting that it will be some time before sufficient supplies of adjusted units become available for the VCM, with such credits in high demand among CORSIA and other international compliance schemes (see Table 1)⁹.

The big question centres on how non-adjusted credits can be used. While the role of adjusted credits in mitigating companies’ footprints is clear and easily claimed, allowing non-adjusted credits to be used against emissions reduction targets would be counter-intuitive and represent double counting. Yet, no consensus could be reached in Glasgow over the function and associated claims of non-adjusted offsets.

Overall, the industry view is that non-adjusted credits will most likely be used by corporations to claim against Environmental, Social and Governance (ESG) indicators, aside from offsetting emissions. Nonetheless, greater clarity is needed regarding the claims which companies will be able to make, and whether both, adjusted and non-adjusted credits can co-exist in the medium-term. It is hoped that a report by the Voluntary Carbon Markets Integrity Initiative (VCMI) will provide actionable guidelines, expected in April 2022¹⁰.

Divided gatekeepers

Another source of uncertainty emerging from Glasgow is how VCM accreditors will look to reflect the updated rulebook. Gold Standard and Verra, as two key players, have already initiated processes to offer offset credits with corresponding adjustments, however their approaches vary.

Gold Standard plans to phase in corresponding adjustments by 2025 and has opened registrations to its ‘early-mover programme’ for project developers interested in issuing adjusted credits¹¹. Verra, on the other hand, supports the continuation of non-adjusted credits for voluntary offsetting purposes and is preparing to introduce an Article 6 label, to be attached to adjusted credits obtained by host governments¹².

This division between key stakeholders within the market creates uncertainty for investors. With accreditors pursuing different approaches, buyers are left unsure regarding the appropriate conditions of respective instruments and what can be legitimately claimed as an offset. This will need to be addressed in the coming months to ensure market liquidity.

SGiven that host governments are the carbon owners, ultimately the accreditors must align their approach for integrating Article 6 with the employed position of individual countries where projects are based.

Additional(ity) complexity

Macroeconomics aside, the most technical outcome of Article 6 relates to additionality: the single most important determinant of carbon quality. The term refers to the likelihood that any given offset credit leads to a tonne of CO₂e being avoided or sequestered that would not have otherwise happened. Considering that counterfactual scenarios cannot be observed, this is inherently difficult to accurately discern. Nevertheless, it is an essential mechanism without which there would be neither issuance nor a tradable instrument.

Accreditors have historically treated additionality as a binary question in order to determine whether credits can be issued. The CDM and other independent standards have allowed a blanket formula to be used for calculating baseline carbon emissions, whereas the new UN mechanism demands that tailored baseline estimates are determined to reflect the circumstances of individual countries, as reported in their NDCs¹³.

This will likely change the way independent standards evaluate additionality too¹⁴. The headline of all of this? Assessing offset quality just got (even) harder.

How additionality should be assessed against host countries’ plans for future environmental regulations is a question that still needs answers. As it stands, there is scope for perverse incentives since governments may be tempted to lower climate ambition in order to maximise carbon credit revenues.

These new developments demand a forward-thinking approach to additionality, wherein changing policy environments are accounted for and compared relatively across national (and even regional) borders. Regular monitoring and transparent reporting on individual countries’ NDCs are crucial for the sustained reliability of this process¹⁵.

One thing is for certain; Article 6 has forced a paradigm shift. Notions of project-based baselines and additionality associated with the Kyoto Mechanisms/CDM have been transformed into the ambition raising concept of Article 6, yet how host countries will implement the marriage of NDCs and Article 6 remains to be seen¹⁶.

SA timely entrance

Introducing the world’s first API and web-based intelligence platform providing data analytics for the VCM: BeZero Carbon Markets (BCM). Not all carbon offsets are born equal, and while each credit intends to avoid or sequester a full tonne of CO₂e, rarely is this the reality.

BCM uses a six-risk factor framework to provide clarity and transparency for the VCM. It assesses the efficacy of carbon projects in order to provide research ratings; combining climatic and earth sciences, sell-side financial research, data and technology, engineering, and public policy. By providing an indication of the likelihood that an offset credit does what it says on the tin, BCM helps the whole value chain to navigate complex carbon markets. This includes project developers, investors, intermediaries and end consumers.

In a post-Glasgow environment, with clear signs that the market is ripe yet without the tools to inform smart investment decisions, BCM offers a means for interrogating and comparing credits to ensure value for money and maximum climate benefits.

What’s next for the VCM?

Although the final rules of Article 6 still require further tweaking, the agreement at COP26 has undoubtedly staked a claim for carbon markets and confirmed that the VCM will form a crucial part of the fight against climate change. The processes adopted in Glasgow provide a solid foundation for private and public actors to employ market-based mechanisms to meet their climate goals, and contribute towards the UN Sustainable Development Agenda. Now, time is of the essence for new structures and implementation processes to be developed.

As for next steps, a number of work programmes have come out of Glasgow to hopefully iron out the fine details, which should be finalised at the next COP in Egypt next year.

The new UN body created by Article 6.4 will meet twice in 2022. Updates to the NDCs are also expected in 2022¹⁷. UN’s ICAO’s Technical Advisory Body will reassess CORSIA units’ eligibility for compliance beyond the 2021–2023 pilot phase¹⁸.

Meanwhile, the aforementioned VCMI report to be released next April should provide clearer implementation guidelines for VCM participants — watch this space.

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