ANALYSIS: Two-track UN carbon credits may cause headache for corporate offsetting

Quantum Commodity Intelligence - The establishment of a two-track carbon market at the UN could create a headache for companies that wish to invest in cutting emissions abroad to green their business credentials, observers said Monday.

On Saturday, the UN approved the rules on how a future carbon market may work, passing so-called Article 6, which establishes the rulebook for carbon trading under the Paris Agreement to ensure, among other things, there is no double-counting of credits during trade.

This involves allowing countries to create two types of carbon credits from emission reduction projects they host – one that has to be approved by a UN body and will result in a higher target for the host of the project corresponding to the number of credits it has sold, and another type of credit that does not need to be accounted for.

Observers warn the reputational and legal risk of not understanding the difference could be significant.

"It is immediately clear that establishing credible guidance on the claims that companies and other non-state actors can make regarding the voluntary use of carbon credits is more important than ever," said the Voluntary Carbon Market Integrity Initiative in a note Monday.

Booming

Born in the 2000s out of a desire to create additional sustainable benefits rather than simply cutting greenhouse gases such as those under the UN, the voluntary carbon market has rocketed on the back of corporate willingness to "go green," with prices for carbon offsets up sevenfold this year alone by some estimates.

According to Ecosystem Marketplace, the global value of the market reached $1 billion this year.

And large energy companies and trading houses are keen to get in on the act, with analysis published by consultants at Trove Research estimating around 5% of credits bought this year are destined to "green" the burning of fossil fuels, such as crude, fuel oil and LNG.

Yet part of the problem has always been how to avoid double counting – whereby both the seller country claims a reduction in meeting its goal under the 2015 Paris Agreement to cut emissions, and the buyer of the credit claims also to have cut its emissions, often in marketing material and corporate sustainability and responsibility reports.

This has never been an issue before, as developing countries that host these projects have never had targets to cut emissions enshrined in an international pledge and review scheme.

Until now, that is.

Two credits

To solve the riddle, the UN came up with the corresponding adjustment notion while also allowing countries to issue a second set of credits without making adjustments to their targets.

The reason for allowing non-adjusted credits are many, but two examples are to allow the benevolent funding of climate cuts by a third party that does not wish to use the reduction for any purpose and for domestic emission reduction crediting mechanisms that only serve domestic carbon trading markets.

Where the problem lies for corporate buyers is where they buy credits that will not be tied to corresponding adjustments yet go on to claim they have offset emissions.

This is because, in this case, the country would not increase its emissions target accordingly to match the emission credits it has sold. Hence both parties claim credit for the same reduction.

According to Lambert Schneider, a climate policy veteran who was part of the EU's negotiating team on the Article 6 talks and a member of the UN panel overseeing carbon markets, Switzerland tried to introduce language in the decision text that would regulate what claims can be made in respect to non-authorised units, but that failed.

"No consensus could be reached, and the debate will continue elsewhere. Ultimately, governments or courts may start regulating what claims companies can truthfully make in association to carbon credits that are not backed by corresponding adjustments," Schneider said Monday.

Secretariat

Corporate buyers may wish to try and buy credits that are only attached to corresponding adjustments in the future, although it may take time to set up the new scheme, which includes establishing and staffing a supervisory body and approving methodologies.

For example, it took the UN eight years to properly operationalise the Clean Development Mechanism carbon market after it was formed under the Kyoto Protocol.

However, it only took three years from the establishment of the CDM rulebook in 2001 and that process was hampered by the delayed ratification of Kyoto, an obstacle Paris does not face.

Axel Michaelowa, a partner at climate consultancy Perspectives, told a webinar Monday he was optimistic that methodologies approved by the UN under the CDM will be approved under the new scheme, a move that would save a lot of time for carbon market investors.

However, given projects that claimed to reduce emissions by avoiding deforestation (REDD+) were never approved by the CDM's executive board, it may not be such a straightforward process to get such projects, which account for a huge number of credits and trade at a premium to others, the green light.

In addition, for political and economic reasons, observers say many countries may not wish to increase their emissions targets by selling cheap reductions to third parties, particularly in huge multi-million credit deals such as those related to avoided deforestation.

"I can see there being a reluctance to blanket sign off on millions of tonnes of adjustments in the future, particularly if you think you can get finance from other sources to do it (without adjusting your target)," said one observer that declined to be named.

That is, perhaps, he said, why Brazilian negotiators were reluctant to bring in double-counting rules in the past.

What about existing credits?

What Glasgow did decide on were two thorny issues: whether to allow legacy CERs – carbon credits under the CDM – for use to meet national targets and whether to let legacy CDM projects apply for status under the new mechanism.

On the first issue, the COP allowed CDM projects registered after 2013 to produce credits that countries could use to meet emission reduction commitments – with estimates by the New Climate Institute and Oeko Institute suggesting this could total 300 million credits.

However, other analysts say this figure is inflated and the real figure may be half of this.

And on the second issue of legacy projects, the COP allowed them to continue to generate reductions from 2020 onwards, but only if they are backed by a corresponding adjustment by the host country, a move that heavily disincentivises countries to allow them to generate credits for other countries to use.

This again could create a reputational headache for buyers of credits from those projects, according to Schneider.

"Whether and how much Article 6 will undermine climate mitigation efforts could heavily depend on how these factors play out. One possible scenario is that governments will approve these projects for transition but not authorise them to be backed by corresponding adjustments. This could lead to large inflows of non-authorised credits with low or no quality," Schneider said in a blog published Monday.