Navigating Article 6: Understanding Carbon Trading and the Risks for businesses developing carbon projects

From COP26 to COP29vone of the main priorities for negotiations in Baku

Article 6 of the Paris Agreement plays a crucial role in facilitating international cooperation on climate change through carbon trading mechanisms like ITMOs. However, understanding the complexities and risks—especially regarding revocation—is essential for all stakeholders involved.

What is Article 6?

Article 6 recognizes that countries can work together to meet their Nationally Determined Contributions (NDCs)—the commitments each country makes to reduce greenhouse gas emissions. The article is divided into three main parts:

• Article 6.2: Provides a framework for countries to trade ITMOs bilaterally or multilaterally.
• Article 6.4: Establishes a centralized mechanism for generating carbon credits through specific projects.
• Article 6.8: Focuses on non-market approaches to cooperation that do not involve trading.

Understanding the Risks of Revocation in Article 6.2

In the complex landscape of international climate agreements, the risk of revocation under Article 6.2 of the Paris Agreement has emerged as a significant concern for nations engaging in carbon trading. This article explores why potential buyers may hesitate to invest in emissions reductions if they fear that these commitments can be retracted at any moment.

The Context of Article 6.2

Article 6.2 allows countries to trade emissions reductions through Internationally Transferred Mitigation Outcomes (ITMOs). This mechanism is designed to facilitate cooperation among nations in achieving their Nationally Determined Contributions (NDCs) by allowing them to buy and sell carbon credits[1][2]. However, the operationalization of Article 6 has faced challenges, particularly regarding the Letters of Authorisation (LoAs) that underpin these transactions.

The Role of Letters of Authorisation (LoAs)

When a host country agrees to sell an ITMO, it must issue a Letter of Authorisation. This document is a commitment from the host country to remove the corresponding emissions reduction from its own GHG emissions balance, thus allowing it to be counted towards the buyer’s inventory[4]. However, this commitment is inherently uncertain; if a host country realizes it has granted too many LoAs, it may revoke its authorization to protect its own NDC targets.

The Risk of Revocation

This potential for revocation creates a significant barrier for buyers:

• Market Uncertainty: Buyers may be reluctant to invest in ITMOs if they believe that the host country could retract its commitment at any time. This uncertainty undermines confidence in the market and can lead to reduced participation in carbon trading[1].

• Insurance Solutions: Recognizing this risk, some insurance companies have begun developing products that protect both buyers and sellers against revocation or failure to deliver on carbon promises. This represents a step towards mitigating investment risks but does not eliminate them entirely[1].

Proposed Solutions

To address these concerns, several strategies could be implemented:

• Strengthening Host Country Capacity: Ensuring that host countries have the capacity and understanding necessary to issue LoAs responsibly can help mitigate the risk of revocation. This includes providing clear guidelines on how many LoAs can be granted without jeopardizing NDC commitments.

• Early Corresponding Adjustments: Implementing corresponding adjustments at the earliest possible stage within the “First Transfer” could reduce uncertainty about future revocations. By making these adjustments upfront, both parties can have greater assurance about the permanence of their agreements[1][3].

• Limiting Revocation Scenarios: Establishing specific conditions under which revocations can occur would help create a more stable trading environment. This would involve defining clear parameters that limit revocation to exceptional circumstances rather than allowing arbitrary changes by host countries[5].

Conclusion

The complexities surrounding Article 6.2 and its associated risks highlight the need for robust frameworks that ensure trust and stability in international carbon markets. As discussions continue at COP29 under Azerbaijan’s presidency, addressing the risk of revocation will be crucial for fostering a reliable and effective system for global emissions trading.

By understanding these dynamics, stakeholders can better navigate the challenges posed by Article 6.2 and work towards more sustainable climate solutions.

This article aims to spark discussion among colleagues and stakeholders about the intricacies of Article 6.2 and potential pathways forward. Keep an eye out for further insights on this topic!

Citations: [1] https://carbonmarketwatch.org/2023/11/24/faq-everything-you-need-to-know-about-article-6-at-cop28/ [2] https://carbonmarketwatch.org/2022/11/02/cop27-faq-article-6-of-the-paris-agreement-explained/ [3] https://sdg.iisd.org/news/cop-29-incoming-presidency-paints-its-vision-for-2024-un-climate-conference/ [4] https://abatable.com/carbon-glossary/letter-of-authorisation/ [5] https://www.pd-forum.net/files/pdf_uploads/20231128_Art6-Authorizations.pdf