Using Carbon Markets to Fuel the Energy Transition

This is the first in a series of articles on how Article 6 of the Paris Agreement can spur the clean energy transition, by Tetra Tech Senior Climate Advisor, Rodrigo Chaparro .

Powered by the Article 6 rulebook adopted at COP26, the financial flows around achieving Paris Agreement goals could soar to $1 trillion a year by 2050, according to?International Emission Trading Association estimates .?Governments are taking steps to realize their Nationally Determined Contributions (NDCs) by enforcing mandatory emissions targets or introducing a carbon tax, or both. Those with the most at risk—utilities and large energy consumers—are looking for ways to flip the switch 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 emissions reductions defined in their NDCs. The first two, designed to spark private sector involvement, will use carbon markets to facilitate the transfer of emissions reductions from the country that achieved the reduction to the country that will acquire the reduction. The third, non-market approach 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) .?Although consolidating the new carbon market might take a few years, early movers will have a competitive advantage. Companies “in the know” 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?

1.?????Cooperative Approach.?The first instrument, commonly called the?Cooperative?Approach,?allows the use of direct bilateral arrangements to develop emissions reduction activities in a host country, generating credits, or international transferred mitigation outcomes (ITMOs), that can be transferred to the partner country for use in meeting its NDCs. Under this approach, ITMOs must be generated from activities undertaken since the beginning of 2021 and can be measured in tons of carbon dioxide equivalents (tC02e), or in other non-greenhouse gas (GHG) metrics determined by the country partners.

Some countries are already working toward establishing Cooperative Approaches. In general, the 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. As compensation, the developing country would receive a certain amount of carbon offsets when a specific geothermal project becomes operational.

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 them to another company in another country, who may use them for complying with its own emissions reduction obligations.

This mechanism will replace the Clean Development Mechanism (CDM) established under the Kyoto Protocol and will be operated by the UNFCCC Secretariat. The SDM also requires that the crediting period start no earlier than January 1, 2021. However, some Certified Emissions 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.

Requests to transition existing CDM projects to the SDM must be made no later than December 31, 2023, and approved before the end of 2025. For transparency and accuracy in accounting, the SDM requires companies to use project-based protocols. Meanwhile, countries using the Cooperative Approach will have to provide details on the transfer arrangements through reports, which will be reviewed and made available to the public by the UNFCCC Secretariat.?

How can Tetra Tech help you use these new carbon market instruments to meet emissions reduction goals?

Tetra Tech’s energy consulting and technical implementation services can help clients:

1. Structure schemes for seamless implementation of?Cooperative Approaches?between countries that address project eligibility, compensation mechanisms, financing, regulatory issues, monitoring and verification, and legal advice;
2. Build clean energy SDM portfolios with carbon offsets that can be traded internationally;
3. Identify and acquire quality offsets that can be used to supplement their emissions targets; and
4. Navigate the regulatory space of the new carbon market to ensure compliance and maximize the potential to lower emissions reduction costs.

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Article 6 of the Paris Agreement and the Clean Energy Transition:

1. Using Carbon Markets to Fuel the Clean Energy Transition
2. Three New Business Models to Achieve Carbon-Reduction Goals
3. Four Ways Development Agencies Can Advance Carbon Markets