The Paris Agreement and Carbon Markets: A Quick Overview

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Alexander Ferrigno

Please know that this article is designed to be as short as possible. It is a deeply nuanced area, so I would encourage reading my article here for a deeper understanding.

History

The Kyoto Protocol was many things, but effective was not one of them. However, this precursor left behind a lasting impact, a legacy, that is still in use today. That is establishing “Carbon Markets”. Their function, and their operation under the current regime (Paris Agreement) will be our focus for this article. 

Despite the dissolution of the Kyoto Protocol, this still remains a somewhat useful tool for reducing greenhouse gas (GHG) emissions. Given the far greater ambition of the Paris Agreement, to limit the temperature rise to below 2°C and ideally 1.5°C,1 it makes sense that it has persisted in its use if it remains effective. 

However, carbon markets were originally created under the mechanisms that existed within the Kyoto Protocol, not the Paris Agreement. Meaning the fit isn’t perfect. The Kyoto Protocol relied on “common but differentiated responsibilities”, while the Paris Agreement allows nations to determine their own goals and methods to reach them via “Nationally Determined Contributions” (NDC).2 Moving from mandatory commitments to voluntary ones.3

Carbon markets are capable of being a part of this method, and the mechanisms under the Paris Agreement can accommodate carbon markets to some extent. But gaps in regulation exist because carbon markets were never created with the Paris Agreement in mind, and where there are gaps there are issues. 

Concepts: Offsetting and Additionality

Before we get into the mechanisms, it is quite important to grasp a basic understanding of these two terms. Offsetting essentially involves the balancing of emissions by purchasing carbon credits. These “credits” are a representation of a reduction achieved elsewhere. They can then be traded on the carbon market, allowing for either a greater expenditure of emissions, or the ability to trade them with another country to claim a net-zero balance, or help contribute to their NDC targets. 

This concept is also closely linked to “additionality”, which requires that a project must prove it resulted in a reduction beyond what would have occurred without the project. Ensuring additionality is critical to the credibility of a carbon credit, and helps address issues like double counting.4

Article 6

The key for us here is Article 6. It introduced a cooperative approach, established at COP21, as well as unfortunately vague mechanisms for managing carbon markets.5 Although it should be noted that after years of uncertainty there has finally been an agreed, standardized interpretation of Article 6, which I have written about here.  

Specifically, Article 6.2 allows for the transfer of Internationally Transferred Mitigation Outcomes (ITMOs),6 which basically just allows countries to trade GHG reductions. There are various forms ITMOs but they most commonly facilitate bilateral trading of reductions, similar to the Joint Implementation program under the Kyoto regime. 

But without Kyoto’s Clean Development Mechanism (CDM) and JI, generating carbon credits for trading isn’t possible. Thus, came the creation of Article 6.4, establishing the Sustainable Development Mechanism (SDM).7 It is the successor to the CDM and allows for emission trading under the new regime. Although it does come with the risk of double counting.8 In an attempt to rectify this issue, the Paris Agreement’s rulebook encourages transparency and report any adjustments to their emissions inventories to reflect ITMO usage. However, for now the rules themselves aren’t explicitly expressed in Article 6, leaving plenty of room for gaps in enforcement. 

The Scope of NDCs

The scope of NDCs within Article 6 has found itself to be one of the larger issues with regard to the Paris Agreement. I did touch on this aspect of NDCs from a different perspective in a more recent article here.  

Each country has its own varied targets, some focus on specific GHGs and some focus on particular sectors. A perfect example is China’s decision to focus on CO2 emissions, but ignore GHG emissions.9 The problem stemming from this is that it raises questions about how to account for mitigation outcomes that don’t fall within the scope of the NDC that country has submitted. Especially so when these outcomes are then traded internationally to another country.10 In other words, double counting becomes far more likely when mitigation outcomes outside of their NDC are traded. 

Obviously, there are drawbacks. But the theory that the benefits to allowing the transfer of outside-scope mitigation efforts outweigh the drawbacks is likely true. It does grant the ability to enhance capacity building as well as better emission data collection. But still, they undermine the entire objective of the Paris Agreement. Furthermore, encouraging double counting falsely inflates the reduction data, in turn correctly inflating global GHG emissions.11 More importantly, countries that trade emissions from outside the scope of their NDC allow for other countries to meet their own targets entirely though external efforts, as opposed to applying domestic mitigation action. 

Voluntary Carbon Markets (VCM)

There is not just one form of carbon market, there are both compliance carbon markets, which are heavily regulated and as the name suggests ensures compliance. However, there are also non-international, voluntary carbon market. Early on these domestic markets were still connected to international markets like the EU. Despite the collapse of the EU market there is still a high transaction volume in VCMs, particularly among the financial services sector.12

The operation of these markets is operated also through voluntary standards. Third-party verification, independent credit registries and following the “Gold Standard” guidelines help avoid double counting.13

Despite the Paris Agreement emphasizing the need to maintain environmental integrity within domestic VCMs,14 it still remains a challenge. Particularly considering there is no actual definition of “environmental integrity” despite being referenced frequently throughout the text of the Paris Agreement. We can develop our own definition as best as possible though, at the very least, it should mean there is a genuine reduction to GHG, and does not lead to an increase in emissions had the transfer never taken place.15

Governance from market-to-market varies, and public and private sectors often intersect, creating quite a complex landscape for market regulation. Public sectors will face regulation and policies from government, while private ones will see resistance from stakeholders due the economic implications of emission reductions. This just leads to different standard and practices.16 Sometimes these practices overlap, this can be seen when India opted to use the Gold Standard guidelines over the CDM’s criteria allowing them to maintain sovereignty over their carbon market.17 Under the Paris Agreement this type of fragmentation is less of an issue compared to during the Kyoto era, largely due to the shift towards a bottom-up approach.18 However, the flexibility granted to these states has created a sort of “grey zone” between compliance based and voluntary driven targets. This has just complicated the landscape more. 

Corresponding Adjustments

This is a measure implemented to help avoid double counting. Essentially, when a transfer of an ITMO takes place, both countries involved in this transaction must adjust their GHG accounts accordingly. One country shall deduct the reduction from its GHG inventory, while the other adds to theirs.19

Of course, it is not that simple. When a transfer takes place involving a mitigation action outside the scope of a country’s NDC, it raises questions about the role of the transferring country’s role in accounting. This extends further to trades happening in VCMs, as these are also not covered by Article 6.4, so there is uncertainty as to whether these need corresponding adjustments.20 As they are not ITMOs, they technically do not need to be adjusted. If VCMs were to be linked to the Article 6 framework, it could enhance accountability. 

This is just a very brief introduction into the complicated concept of corresponding adjustments, if you want to read about linking it VCMs, the adjusting of NDC targets, debates about adjustments and carbon neutrality, as well as how to strengthen carbon market integrity, you can click here for deeper insights.

To Wrap Up

The Paris Agreement is still enduring growing pains, particularly with carbon markets. With the recent developments at COP29, we can hope to rectify some of the issues that we currently have. However, countries need to navigate the complexities of additionality, adjustments and double counting with caution. The success or failure of the Paris Agreement in this aspect is largely dependent on the transparency and integrity in climate action. Meanwhile additionality will forever remain a cornerstone of carbon markets, as it ensures the reduction is a genuine one. However, the need for a proper baseline to prove these are meaningful reductions remains crucial, but this might be challenging from a methodological and political standpoint. To read more you can click here. 

  1. United Nations Framework Convention on Climate Change (UNFCCC) Adoption of the Paris Agreement, COP21, Paris: United Nations [2015] Article 2 (1) (a)  ↩︎
  2. ibid Article 4 (2)  ↩︎
  3. Axel Michaelowa, Igor Shishlov and Dario Brescia, ‘Evolution of international carbon markets: lessons for the Paris Agreement’ (2019) 10 WIREs Clim Change 1-24, 12 ↩︎
  4. Sebastian Lang et al, What future for the voluntary carbon offset market after Paris? An explorative study based on the Discursive Agency Approach (2019) 19 Climate Policy 414-426, 419 ↩︎
  5. Paris Agreement (n 1) Article 6 ↩︎
  6. UN Doc FCCC/SBSTA/2017/7, ‘United Nations Framework Convention on Climate Change, Subsidiary Body for Sci. and Tech. Advice, Rep. of the Subsidiary Body for Science and Technology, Advice on Its Forty-Seventh Session’ [2018] sections 87-92 ↩︎
  7. Paris Agreement (n 1) Article 6.4 ↩︎
  8. Double counting is where the same emission reduction is counted by both the buyer and seller, essentially doubling a contribution toward emissions reduction. See Lambert Schneider, et al, ‘Outside in? Using international carbon markets for mitigation not covered by nationally determined contributions (NDCs) under the Paris Agreement’ (2020) 20 Climate Policy 18-29, 19  ↩︎
  9. see generally UNFCCC, China’s Submission on Further Guidance for the Nationally Determined Contributions under the Paris Agreement, available https://www4.unfccc.int/sites/SubmissionsStaging/Documents/199_279_131197033692013328-Submission%20on%20NDC%20China.pdf ↩︎
  10. Lambert Schneider, et al, ‘Outside in? Using international carbon markets for mitigation not covered by nationally determined contributions (NDCs) under the Paris Agreement’ (2020) 20 Climate Policy 18-29, 19 ↩︎
  11. ibid 21 ↩︎
  12. Guy Turner et al, ‘Future Demand, Supply and Prices for Voluntary Carbon Credits—Keeping the Balance’ (2021) Trove Research, 7 ↩︎
  13. Sebastian Lang et al, What future for the voluntary carbon offset market after Paris? An explorative study based on the Discursive Agency Approach (2019) 19 Climate Policy 414-426, 416 ↩︎
  14. Hanna‐Mari Ahonen et al, ‘Governance of Fragmented Compliance and Voluntary Carbon Markets Under the Paris Agreement’ (2022), 10 Politics and Governance 235-245, 236 ↩︎
  15. Lambert Schneider & Stephanie La Hoz Theuer, ‘Environmental integrity of international carbon market mechanisms under the Paris Agreement’ (2019) 19 Climate Policy 386-400, 388 ↩︎
  16. Ahonen (n 14) ↩︎
  17. Jon Philips, ‘Governance and technology transfer in the Clean Development Mechanism in India’ (2013) 23 Global Environmental Change 1594–1604, 1602 ↩︎
  18. Ahonen (n 14) 237 ↩︎
  19. ibid 239 ↩︎
  20. ibid 240 ↩︎
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