COP27: carbon market / Article 6 rules - key takeaways

As was anticipated, COP27 did not make any great strides when it comes to the carbon markets (aka the “Article 6” rules). 

At COP26 last year, countries momentously agreed the broad framework for establishing a new international carbon market under Article 6 of the Paris Agreement. This year, they largely kicked the can down the road, deferring decisions on the detailed rules and guidance for implementing that framework (including the critical issue of the timing and scope of Article 6 authorisations, together with the scope of a Party’s ability to amend or revoke such an authorisation) to COP28 next year.

Mitigation contributions – “use” is the key 

In Glasgow, the rules to prevent ‘double counting’ of emission reductions were agreed: if one country buys an ITMO (including an ITMO issued pursuant to the Article 6.4 mechanism) from another country for use towards its own target, the host country needs to make a corresponding (upwards) accounting adjustment to its national emissions inventory. This also applies to such credits purchased for use in international compliance markets (notably CORSIA, the aviation industry’s emission trading scheme).

One significant development at this year's COP27 was the introduction of a new class of Article 6.4 carbon credit: a mitigation contribution unit ("Contribution Art 6.4 ER"). This effectively bifurcates the Article 6.4 mechanism – different rules will apply to the credits resulting from an Article 6.4 approved project, depending on their use. Contribution Art 6.4 ERs are not authorised by the host country for any specific use (as opposed to "Authorised Art 6.4 ERs" which are authorised by the host country for use towards the achievement of NDCs and/ or other international purposes). This is important because only Authorised Art  6.4 ERs qualify as ITMOs and therefore require a corresponding adjustment by the host country when transferred.

The text goes on to set out the measures that a Contribution Art 6.4 ER “may be used for”, including mostly domestic schemes. The problem is that the shopping list is preceded by “inter alia” (or "amongst others" to you and I). The effect of the murky language creating this new class of credit seems to be that the host country can transfer Contribution Art 6.4 ERs to a buyer in another country without a corresponding adjustment, and that Contribution Art 6.4 ERs can be used for an open class of uses. However, what is clear is that the emission reduction will contribute to the reduction of emission levels in the host Party regardless of its transfer. It has been argued that by labelling these new credits a "contribution", this implies that companies who purchase such credits should not use them to offset their own emissions or to count towards that company’s emissions target. Rather, the purchase of such a Contribution Art 6.4 ER should be seen as a way to fund climate action in the same way as results-based financing would.  However, there is nothing in the text expressly preventing such use. So this will leave many market participants wondering whether they can or should use this new class of credits as perhaps they had intended. 

Wood for the trees 

Whilst this new text gives host countries yet another option in connection with the potential "regulation" of emission reduction activities within their borders under Article 6 of the Paris Agreement, it is important to remember that the voluntary carbon market continues to operate in parallel. It is still within the host country’s gift to allow that status quo to remain, or to merge these markets by requiring emission reduction activities to fall under the Article 6.4 mechanism or by requiring emission reductions generated by such activities to be authorised as ITMOs under Article 6.2.

Given that the consequence for host countries of bringing activities under the umbrella of Article 6 includes additional reporting requirements for the host country and could trigger a corresponding adjustment as set out above, it is questionable whether there will be sufficient motivation, or capacity, to do so at scale in the short term. 

Finally, we note that the new text confirms that Contribution Art 6.4 ERs will be subject to the same fee structure and surrender requirements as Authorised Art 6.4 ERs, including SOP, issuance fees and overall mitigation contributions. This will add significant transaction costs to such projects as compared to similar projects undertaken in the voluntary carbon market. This is likely to further dampen appetite for investment into such projects.

For further coverage of this year's summit, see our COP27 page.