Using Carbon Markets to Fuel the Energy Transition
This is the first in a three-part series exploring how Article 6 of the Paris Agreement can spur the clean energy transition.
According to International Emission Trading Association estimates, Article 6-powered financial flows to achieve Paris Agreement goals could soar to $1 trillion a year by 2050. Governments are taking steps to realize their Nationally Determined Contributions (NDCs) by enforcing mandatory emission targets, introducing a carbon tax, or both.
Those most impacted—utilities and large energy consumers—are looking for ways to reduce reliance on coal, finance and develop new clean energy generation plants, and advance the energy transition. The carbon finance options defined in Article 6 can drive down the cost of cutting emissions, offering a clear path forward.
What are the implications of Article 6?
Article 6 spells out three instruments countries can use to meet the emission reductions defined in their NDCs. The first two instruments are designed to spark private sector involvement. These instruments will use carbon markets to facilitate emission reduction transfers from the country that achieved the reduction to the country that will acquire the reduction.
The third, non-market instrument enables countries “to work together to achieve mitigation and adaptation, as well as sustainable development and poverty reduction,” according to the United Nations Framework Convention on Climate Change (UNFCCC).
The three carbon finance options defined in Article 6 can drive down the cost of cutting emissions, offering a clear path forward.
Consolidating the new carbon market might take a few years, and early movers will have a competitive advantage. Companies on the leading edge of the market will be able to supplement their in-house mitigation measures with legitimate carbon offsets.
What are the market-based instruments, and how do they work?
Instrument 1—Cooperative Approach
The first instrument, commonly called the Cooperative Approach, allows the use of direct bilateral arrangements to develop emission reduction activities in a host country. These arrangements generate credits, or international transferred mitigation outcomes (ITMOs), that can be transferred to the partner country for use in meeting its NDCs. ITMOs must be generated from activities undertaken since the beginning of 2021 under the Cooperative Approach. These ITMOs also can be measured in tons of carbon dioxide equivalents (tC02e) or in other non-GHG metrics determined by the country partners.
Some countries are already working toward establishing Cooperative Approaches. Generally partner country governments jointly determine the funding conditions and which activities are eligible to generate carbon credits. A donor can acquire offsets, either for the government or for private companies funding the projects.
For example, a developed country with vast experience in geothermal power might support the expansion of this technology in a developing country that is heavily reliant on coal and lacking geothermal expertise. The developing country would receive a certain amount of carbon offsets as compensation when a specific geothermal project becomes operational.
Instrument 2—Sustainable Development Mechanism
The second instrument, informally called the Sustainable Development Mechanism (SDM), operates between companies. The SDM defines rules for a multilateral credit mechanism that enables a company to reduce emissions in a country and sell credits to another company in another country. The latter company may use them for complying with its own emission reduction obligations.
This mechanism replaces the Clean Development Mechanism (CDM) established under the Kyoto Protocol and is operated by the UNFCCC Secretariat. The SDM also requires that the crediting period start no earlier than January 1, 2021. However, some Certified Emission Reductions (CERs) issued under the CDM can be used toward achievement of an NDC if the CDM project was registered on or after January 1, 2013.
Although there are hurdles to clear for companies wishing to take advantage of these new market mechanisms, the clarification of the rules reduces market uncertainty for the private sector by facilitating the linking of emissions trading systems between jurisdictions, enabling new mitigation activities to start under the SDM, and setting rules to move projects operating under the CDM to the SDM.
Companies must request to transition existing CDM projects to the SDM no later than the end of 2023; requests must be approved before the end of 2025. The SDM requires companies to use project-based protocols for transparency and accuracy in accounting. Meanwhile countries using the Cooperative Approach must provide details on the transfer arrangements through reports, which the UNFCCC Secretariat will review and make available to the public.
How can Tetra Tech help clients use these new carbon market instruments to meet emission reduction goals?
Tetra Tech’s energy consulting and technical implementation services can help clients:
- Structure schemes that address project eligibility, compensation mechanisms, financing, regulatory issues, monitoring and verification, and legal advice for seamless implementation of Cooperative Approaches between countries
- Build clean energy SDM portfolios with carbon offsets that can be traded internationally
- Identify and acquire quality offsets that can be used to supplement their emission targets
- Navigate the regulatory space of the new carbon market to support compliance and maximize the potential to lower emission reduction costs
Read more from Rodrigo about how Article 6 of the Paris Agreement can spur the clean energy transition: