As most of you know, we are currently in the era of the Paris Agreement, with a global consensus on how we plan to fight climate change. It was agreed upon in 2015 by the members of the Conference of Parties (COP) to the United Nations Framework Convention on Climate Change (UNFCCC). This marks the beginning of what some call the Paris Agreement Era, whereby almost all countries in the world have committed to taking concrete actions on climate change and reporting their progress to the international community. Countries will attempt to hold each other accountable, and increase ambition over time, while also prioritizing climate adaptation and sustainable development among developing countries.

One tool for climate action, among many, is voluntary offsetting, whereby companies can offset their own emissions by buying units of emissions reduced elsewhere that have been audited and verified. Each unit, also called “carbon credit”, is equivalent to one tonne of CO2e (a standardised unit of greenhouse gases). This takes place in the Voluntary Carbon Market (VCM) and is a flexible way for companies to achieve their goals on the way to becoming net zero. But how does this fit into the broader context of the Paris Agreement? And what do recent developments of the Paris Agreement (such as Article 6) mean for the voluntary market? This blog post will start to unpack these questions and provide some insight into how this all fits together, and where it may be headed.

The Voluntary Carbon Market: Where did it come from and why does it exist?

The concept that entities can voluntarily buy emissions reductions to achieve their own objectives has been around for a while (in fact, the first carbon offsetting project took place in 1989 – an agroforestry project in Guatemala [1]) but became globally recognized in 1997 through the Kyoto Protocol (the first agreement on climate change signed by the majority of the world’s countries). Essentially, a market for the voluntary trade of units of emission reductions was laid out so that industrialized countries could meet their emissions reductions targets by funding projects in developing countries and buying these units of emissions reductions.

This mechanism, while by no means flawless, allowed investment to flow into climate projects in the Global South while industrialised countries had access to flexibility for more efficient targeting of their emission reductions. The framework for doing this was called the Clean Development Mechanism (CDM), and it allowed countries to use purchased credits towards their national objectives laid out in the Kyoto Protocol. The CDM indirectly gave rise to the Voluntary Carbon Market (VCM), as economic entities, who were not constrained by law to reduce their emissions, started buying credits from the CDM to offset their emissions voluntarily.

Currently, organisations active in the VCM can buy carbon credits generated from projects that either remove greenhouse gases from the atmosphere (e.g. tree planting) or avoid greenhouse gases from being emitted to the atmosphere (e.g. switching a power source from coal to solar).

Since it is unregulated, organisations in the VCM have multiple choices when buying carbon credits, all of which are created by following standardized methodologies based in science and are issued by independent certification standards who mandate and conduct audits and other checks. When a buyer purchases and then retires (i.e., “cancels”) a credit, it represents a tonne of carbon already removed from the atmosphere or avoided, and this can balance out the buyer’s own emissions. The VCM is currently valued at $2 billion USD and is predicted to grow by a factor of between 5 and 20 by 2030 [2] as shown in the figure.

Paris Agreement refresher

When adopted in 2015, the Paris Agreement was hailed as the most ambitious and broadly agreed-upon climate pact to date and marked a turning point in global climate policy with nearly every country signing on. Countries who have signed the Agreement present their targets for emissions reductions in a plan called a Nationally Determined Contribution, also known as an NDC. These are revised every five years, to update progress on their goals and preferably increase ambition by setting even higher targets.

Financing climate action is an important aspect of the Paris Agreement. Similar to the Kyoto Protocol and its CDM framework, the Paris Agreement sets out rules and guidance for voluntary cooperation to reduce emissions. The Agreement is made up of 29 articles, the 6th of which lays out a framework for voluntary international cooperation. The idea is that flexibility and voluntary emissions reductions can improve efficiencies in reducing emissions, by notably financing the “low hanging fruit” first, while working up to the harder-to-decarbonize sectors. Global cooperation also means that projects needing financing in developing countries can have access to a broader range of financial instruments, which can address both climate and development challenges. So, let’s dig into Article 6!

What’s all the fuss about Article 6?

Article 6, which sets the stage for international voluntary cooperation under the Paris Agreement, underwent important developments at COP26 in Glasgow in 2021 and is becoming increasingly relevant to those involved in the VCM. The Article lays out rules for both market (in articles 6.2 and 6.4) and non-market cooperation (in article 6.8). We will focus on the market-based cooperation, as these articles most closely resemble the current VCM and are the most likely to impact it.

Article 6.2 provides for the trade of ITMOs (Internationally Transferred Mitigation Outcomes), which are similar to carbon credits, but are exchanged on a voluntary basis between a buyer country and a seller country. The idea is that these emissions reductions can be used towards the NDC of the buyer country, but not the NDC of the seller country.

Article 6.4 establishes a central repository for storing and voluntarily trading carbon credits. It essentially replaces the CDM from the Kyoto Protocol era. This new repository will be governed by the UNFCCC, which will issue credits for emissions reductions and store them in a registry (in the VCM, this is currently done by a selection of non-profit organisations such as the Verra and the Gold Standard). Similar to their rules around ITMOs, a carbon credit traded under Article 6.4 will only be claimable by the buyer country or the host country but not both. This means that the country in which this project is located must deduct this emission reduction from its NDC before selling the credits to the buyer (who can, in turn, claim this emission reduction).

This process whereby host countries must deduct the emission from their national GHG inventory (to ensure it is not reported to the UNFCCC) is known as a corresponding adjustment, and its goal is to avoid double counting (whereby a single credit is counted by two entities) as illustrated in the figure.

While corresponding adjustments are yet to be operationalised, individual host countries are deciding whether to also apply or require these for credits issued by the independent certification standards used in the VCM. Similarly, buyers of carbon credits issued by independent certification standards are wondering whether they will be able to continue making offsetting claims without host countries adjusting their inventories. Importantly, unlike under the VCM, the carbon credits issued under Article 6.4 can also be used towards the NDC’s of buyer countries, which would require corresponding adjustments to be made.

Normally, the VCM is just for voluntary purposes. However, certain compliance schemes such as CORSIA (Carbon Offsetting and Reduction Scheme for International Aviation) allows airlines to use carbon credits indiscriminately issued from a range of certification standards as long as they are associated with a corresponding adjustment. This shows the progressive and increasing relevance of corresponding adjustments for independent certification standards and the VCM.

How does the Voluntary Carbon Market interact with the Paris Agreement?

Currently, the VCM sits outside of, but in a way alongside, the Paris Agreement. The buyers of credits under the VCM are private enterprises not constrained by law to do so, whereas the buyers of credits under the Paris Agreement will be countries. Moving forward, buyers on the VCM will be able to buy credits issued by independent standards (as now) as well as credits issued under Article 6. However, carbon credits eligible under the Paris Agreement (for countries to meet their NDCs) will only be those issued under Article 6.

Many countries have compliance markets which mandate emission reductions from carbon intensive sectors by law. However, with broader acknowledgement of the need for climate action, and increased pressure from the public and consumers on the role of private enterprises in contributing to climate change, the VCM is increasingly used for offsetting purposes. Offsetting is a way for companies to contribute to climate action above and beyond reducing emissions within their value chain, and a growing number of companies are offsetting in line with science-based targets in order to achieve “carbon neutrality” or “net zero” status. This is happening in tandem with increased ambition from national governments, as they revise their NDCs and attempt to hold each other accountable on meaningful progress.

Developments to Article 6.4, namely the structuring and formulation of a centralized credit repository and rules of authorising project activities, could have significant impacts on the VCM. This new market might lead to stricter rules for the VCM and impact its trends and participation. For example, the VCM does not currently require buyers to have corresponding adjustments for the credits they use. The idea here is that corresponding adjustments are not required if a credit is reported once at the international level (to the UNFCCC through a country’s NDC reporting) and once at the company level (on the carbon footprint of a private enterprise, for example).

Another reason for the lack of corresponding adjustments in the VCM is the fear that they could act as operational barriers for low-income countries to access funding for climate projects (by requiring authorisations from national government, who may be reluctant to do so, and prevent them from accounting emission reductions as part of their mitigation targets) and therefore impede the channelling of private finance into developing countries with limited financial options for their projects.

However, the current lack of requirement for corresponding adjustments in the VCM might not be here to stay. Under Article 6.4, if a corresponding adjustment is not made, the emissions reduction is relabelled as a “mitigation contribution” and these cannot be used for offsetting purposes. There remain questions as to whether this distinction and its implications for offsetting could send signals to the VCM (for example, by impacting buyer preferences).

As countries set their domestic rules to govern the use of Article 6, they are increasingly regulating projects certified to independent certification standards as well. These could have significant implications for project developers and buyers of the VCM.

Evidence shows that allowing for access to voluntary, cooperative approaches for reducing emissions can in fact increase ambition for meaningful climate action [3]. However, recent concerns on the integrity and transparency of some carbon projects as well as accusations of greenwashing in how companies communicate these, can erode trust in the VCM.

For the VCM to align with the goals of the Paris Agreement, transparency and integrity need to be prioritised. A range of initiatives and organisations have been promoting good practices, including the Voluntary Carbon Market Initiative (VCMI), the Integrity Council for the Voluntary Carbon Market (ICVCM), and the University of Oxford (with their Oxford Principles for Net Zero Aligned Carbon Offsetting).

Where this is all headed: what you need to know

As this develops, and the norms and institutions evolve, different actors in the climate space will adapt to these changes in diverse ways. Countries in which carbon projects take place (i.e. host countries) are currently strategizing on how to best engage with the VCM while still achieving their NDCs. The decision of whether to authorize emissions reductions to be exported and used under, say, Article 6 could present a trade-off as they could no longer be applied towards their NDC. There are several initiatives attempting to support host countries to build capacity and strategize, such as the A6 Implementation Partnership and the Supporting Preparedness for Article 6 Cooperation (SPAR6C), among others.

Key players in the VCM may need to adapt to changes and trends in this space, and we can in fact already see this happening. Project developers and investors are similarly watching the development of Article 6, to see the impacts it may have on the VCM and the viability of certain types of projects in certain regions. Two of the principal VCM standards, VCS and the Gold Standard, have begun elaborating their positionings on Article 6 and its implications. Both standards have begun developing special labels for credits that have been authorized by host countries to have corresponding adjustments (and therefore engage with Article 6). Voluntary buyers of carbon credits will also be affected by developments in this space, and some may even be asking whether the VCM warrants continuation with an increasingly ambitious Paris Agreement. However, recent research shows that private enterprises who voluntarily purchase carbon offsets are also those who have taken the most action on reducing their own emissions before engaging in offsetting of residual (i.e., leftover) emissions [4,5].

If we are to achieve the goals of the Paris Agreement, we must understand the interactions between the VCM and these goals. A global understanding of the importance of putting a price on carbon as well as the urgent need to rapidly and drastically reduce carbon emissions are the backdrop to this understanding. We hope this blog post has helped build your understanding of the VCM in the Paris Agreement Era and where this may be heading in the future.

HAMERKOP supports project developers and international development organisations with technical and strategic assistance. If you want support understanding or engaging in the VCM and Article 6, feel free to get in touch.

References:

Valentin Bellassen, B. Leguet. The emergence of voluntary carbon offsetting. [Technical Report] 11, auto-saisine. 2007, 36 p. ffhal-01190163f
The voluntary carbon market: 2022 insights and trends: A report by Shell and BCG. 2023. https://www.shell.com/shellenergy/othersolutions/carbonmarketreports.html#vanity-aHR0cHM6Ly93d3cuc2hlbGwuY29tL2NhcmJvbm1hcmtldHJlcG9ydHMuaHRtbA
The Economic Potential of Article 6 of the Paris Agreement and Implementation Challenges, IETA, University of Maryland and CPLC. Washington, D.C. License: Creative Commons Attribution CC BY 3.0 IGO.
Corporate emission performance and the use of carbon credits. Trove Research (2023). https://trove-research.com/report/corporate-emission-performance-and-the-use-of-carbon-credits/
Carbon Credits: Permission to Pollute, or Pivotal for Progress? Sylvera (2023). https://www.sylvera.com/resources/carbon-credits-and-decarbonization

Is There Any Room for the Voluntary Carbon Market in the Paris Agreement Era?