Carbon offsets can be used to meet Paris Agreement goals or voluntary targets. However, it depends on host country policies.
Bearing in mind that the work of elaborating the Paris Agreement is already completed, after nations signed off on the high-level rules regarding carbon markets at the COP26 meeting in Glasgow, we can now look forward to identifying how they will each meet their nationally determined contributions, their climate pledges.
For many Parties to the Agreement, market mechanisms are a key tool in helping them to achieve their mid-century emissions reductions. Whether this is through the UNFCCC’s own Article 6 market or domestic cap-and-trade systems, or even a tax-and-offset hybrid, putting a price on carbon is seen by many countries as an efficient way to drive down greenhouse gas emissions.
Offset Market Choices
Cap-and-trade markets
Some countries have chosen to set up cap-and-trade markets to drive down emissions internally. For instance, the European Union, New Zealand and South Korea have mature emissions trading systems that limit the amount of CO2 that can be emitted in any year. This limit shrinks over time and, if the cap is set correctly, would produce an outcome that meets the country’s mid-century target.
But not all cap-and-trade markets interact with the market for carbon offsets. For example, the EU ETS banned the use of offsets from 2021 and as yet has no plans to allow companies to buy credits for compliance, while California’s market allows a limited volume of specific locally produced offsets from certain project types. The main source of carbon credits, for non regulated markets, comes from the voluntary carbon markets for Net Zero commitments. But a new market is emerging, which could compete for carbon offset supply: the Article 6.4 market created by the Paris Agreement.
Article 6.4 market created by the Paris Agreement
Under this system, carbon credits can be generated in a host country and sold to other countries to help meet their own Paris target.
This Article 6.4 market will coexist alongside the current voluntary market. Both systems will deal in carbon offsets, reductions in CO2 emissions compared to a business-as-usual scenario, that can be used either by governments or by private sector companies to offset harder-to-reduce emissions.
The Article 6.4 market is in the early stages of development, and so it is not yet clear how project host countries will choose to use carbon credits that are generated within their borders.
They may choose to sell these offsets to other countries, using rules and procedures that are yet to be set down by the UNFCCC. Or they can sell the credits to private sector companies for their own voluntary use.
Since there are many thousands of private companies around the world that are not currently covered by mandatory emissions limits, their efforts to reduce greenhouse gas emissions are a purely internal policy initiative. Carbon offsetting enables them to build claims towards carbon neutrality, and meets the growing demand for the private sector to implement stricter environmental and social governance policies.
Host countries choices
The choice facing host countries however is complicated. If they choose to operate within Article 6, they must account for any reductions that are sold outside the country. This “corresponding adjustment” requires them to adjust their emissions inventory upwards, meaning that their Nationally Determined Contribution – their Paris Agreement emissions target – becomes harder to achieve.
The buying country can adjust its Nationally Determined Contribution target downwards, meaning that credit purchases are a way to achieve a Paris goal more easily.
This process effectively turns carbon offsets into sovereign assets, and may change host countries’ attitude towards the sale of carbon credits. A developing or emerging economy may not wish to make its task harder by selling correspondingly adjusted offsets.
However, if offsets are sold to the voluntary market, host countries can choose whether to apply a corresponding adjustment or not. Choosing not to apply one means that the reduction can be counted by the host country towards its Nationally Determined Contribution, but cannot be sold to another government.
But while the detailed processes of Article 6.4 are still being elaborated and are unlikely to be complete until 2024 or 2025, host countries – and indeed private companies – can plan ahead.
It’s likely that developed country governments – OECD members, for example – will be buyers of carbon credits. While many of them already have emissions trading systems, these markets only apply to certain sectors of the economy, and emissions from sectors such as land-use, transport and domestic will still need to be addressed.
Reductions from these sectors are harder to achieve, and carbon offsetting will enable these parts of the economy to contribute to the overall effort.
Some emerging economies are also employing emissions trading systems, some of which allow the use of carbon offsets to achieve compliance. South Korea and China are two examples, and it’s possible that other markets will also expand to embrace the use of offsets.
Still others are using carbon offsets as part of a carbon tax regime, Colombia and South Africa are the two most prominent examples that permit the use of approved carbon credits to meet tax obligations. Other countries are examining this option.
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