Article 6 of the Paris Agreement has been an industry-defining topic since its inception in 2015. With negotiations continuing in Bonn this week, this will hopefully set the stage for further developments at COP this year.
On Thursday 16th May, we hosted a webinar to help equip project developers with a better understanding of the practical implications of Article 6. Alongside Lily Ginsberg-Keig (Policy Manager) and Francesca Cross (one of our Carbon Ratings Scientists), we welcomed Karolien Casaer-Diez, South Pole's Global Senior Director for Article 6 to discuss this important topic.
Key takeaways
Although they are facing uncertainty, developers can seize opportunities in a market that is seeing growing demand.
Interactions with stakeholders - companies, governments, and other developers - are crucial in order to stay on top of market developments and new opportunities, maximising potential benefits.
Ratings remain an integral tool for assessing risk in the Article 6 landscape. The core drivers of BeZero Carbon’s framework can be mapped onto Article 6.
Article 6 framework
The webinar focussed primarily on Article 6.2, and touched on Article 6.4. Under Article 6.2, bilateral agreements can be made between countries to trade Internationally Transferred Mitigation Outcomes (ITMOs), whilst Article 6.4 introduced a new UN mechanism to replace the Clean Development Mechanism, certifying carbon projects under a standardised framework. Despite a lack of any significant decisions at COP28, Article 6.2 has seen positive developments, including the first operational bilateral agreements and innovations such as unilateral authorisations. Currently, 82 bilateral agreements have been established, involving 10 buyer countries and 46 host countries. Buyer countries leading the way include Switzerland, Singapore, and Japan, with significant progress in Ghana, Thailand, and Peru on the host country side.
The flexibility and innovation that characterise the voluntary carbon market (VCM) are helpful in the absence of a functioning Article 6.4. Developers should bear in mind that Article 6 will continue to evolve in the next few years as rules are yet to be agreed at the UN level and details regarding revocation and authorisation, for instance, won't be agreed for some time. This means that developers currently have the opportunity to collaborate with governments and companies to be the first movers in the market and to establish best practice for agreements going forward.
Opportunities and challenges for developers
During the webinar, Karolien Casaer-Diez from South Pole highlighted various opportunities and challenges, whilst also touching on strategic considerations for developers as Article 6.2 takes shape. The key points of her presentation have been outlined below.
Opportunities:
High demand: The announced demand from sovereign countries and Carbon Offsetting and Reduction Scheme for International Aviation (CORSIA) buyers reflects an appetite for high volumes of credits.
Government stamp of approval: Article 6 credits come with government approval and are used for compliance purposes, which can lead to higher prices and opportunities for new types of projects, especially in hard-to-abate sectors.
New market: Article 6 represents a new market responding to different drivers from the VCM; developers can have a defining role in shaping this market.
Challenges:
Supply shortage: There is an anticipated medium-term undersupply of credits as governments can be slow to authorise projects.
New set of policy risks:
Eligibility on the demand side is defined by a small group of sovereigns deciding what kind of projects are going to be eligible for use against their nationally determined contribution (NDCs).
On the supply side, many host countries are still developing regulations and are not ready to authorise credits. Simplified guidance would make it easier for developers to enter the market.
Revocation risk: There is a risk of project authorisation being revoked, which could also deter investment.
‘2030 risk’: There is uncertainty regarding where NDCs will be post-2030, which affects the eligibility of long-term projects.
Asset fungibility: Limited flexibility in authorisation, such as emission reductions being restricted to specific buyer countries' NDCs or purposes, pose a risk if a buyer withdraws.
Strategic measures that South Pole has taken:
Building a strong policy team: It is vital to stay informed on regulatory developments and anticipate market changes. Developers can then build a diversified pipeline based on these expectations and harness opportunities for clients.
Investment in expertise: Significant investment in technical methodology and project development expertise, particularly in hard-to-abate sectors, will allow developers to take advantage of new development opportunities.
Flexible authorisation: Authorisation of credits sales to multiple kinds of buyers (i.e. multiple buyer countries and use towards CORSIA) can provide back-up options in case the original buyers withdraw. Developers should continue to push the message that flexibility is more attractive for investment, to encourage countries to be more flexible in their authorisation.
Hedging bets: It is good to keep options open by exploring opportunities across different markets (Article 6, VCM), value chains, technologies, and countries to maximise potential benefits.
Finding the right investors: In the early stages of market development, finding trusted partners and investors who believe in the market's potential is vital.
In the absence of top-down guidance, there is greater reliance on voluntary initiatives and standards to help shape operations and define quality. First movers are critical to get the ball rolling, paving the way for the rest of the market and kickstarting capacity development. Technical assistance agencies should help governments to better understand opportunities that can be leveraged from the existing VCM.
Case studies
Developers can look to the successes and challenges faced by other projects to inform their own project development under Article 6.
South Pole provided some learnings from their experience working on an Article 6 programme, which facilitated the first ITMO transaction:
It is important that the buy side and the sell side engage with each other directly from early on to make sure that they are aligned.
Note that the timeline for engaging buyers under Article 6 is different than the VCM, as projects are likely to only be authorised for a specific buyer.
Developers should work with both the transferring and acquiring governments throughout the process. This helps to stay on top of ongoing developments and ensures that all the required documentation is available for both parties.
Be patient!
The role of BeZero Carbon Ratings
Whilst the features of different markets vary, many of the core drivers of risk are universal. Currently, our view of ratings in the context of Article 6 is largely informed by the progress of Article 6.2 projects. However, our view may shift to incorporate changes as the market becomes more established.
BeZero Carbon Ratings assess risk in carbon projects to enhance transparency and integrity in this emerging market. The key risks evaluated by our framework can be mapped onto specific Article 6 considerations, focussing on the integrity and assessment of ITMOs, carbon accounting practices, execution risks, and non-carbon benefits.
In the context of Article 6, some key considerations include:
Additionality: The likelihood that ITMOs are the cause of the emission reductions. The way we assess policy will likely evolve for Article 6 credits to reflect the policy support implied by host country authorisation.
Carbon accounting: We recognise that corresponding adjustments were designed to prevent double counting. However, risk linked to baseline setting and greenhouse gas flow calculations still exist independent of these mechanisms.
Permanence: One new consideration here could include revocation risk. The impact of revocation on permanence would depend on the implications for the project’s ongoing management and effectiveness.
Execution risk: The risk that the project will not reach full implementation as planned will be a major consideration, owing to uncertainty regarding regulations and other aspects (pertinent to pre-issuance ratings).
Non-carbon benefits: Assessments of Article 6 credits will consider Sustainable Development Goals contributions and project safeguards to ensure that there are no negative impacts on communities or the environment.
Article 6 presents a promising new channel for financing climate mitigation and maximising positive climate impacts. For project developers, leveraging these opportunities while navigating challenges will require strategic planning, collaboration, and a focus on building resilient and adaptable projects.
Q&A
We saw excellent engagement in the webinar, with lots of participants pre-submitting questions. We’ve shared our responses to the questions below.
How are corresponding adjustments linked to credit integrity?
In our view, corresponding adjustments don’t equate to integrity in a project’s accounting methods. Our assessment considers aspects such as a project’s method of setting a baseline scenario, in addition to how it accounts for project and upstream emissions. Corresponding adjustments may lessen the risk from a double counting perspective, but this does not formulate our view of the integrity of the credit itself.
How are African countries working on Article 6 roadmaps and targets?
We are seeing multiple African countries begin to draft policies and roadmaps for involvement in Article 6 of the Paris Agreement. In particular, countries like Ghana, Kenya, and Uganda have been actively consulting on and implementing specific regulatory frameworks for involvement in Article 6 and carbon markets more broadly. Ghana is seen as one of the most advanced nations with their framework on ‘international carbon markets and non-market approaches’. In addition, countries are supported by initiatives such as the African Carbon Markets Initiative and the Global Green Growth Initiative. These initiatives provide capacity-building programmes and support to African countries planning to utilise the Article 6 framework. In the next two years, we expect that Article 6 carbon markets will rapidly scale across Africa due to their potential to increase climate finance.
Does an Article 6 credit need to be used in the same NDC cycle?
Article 6 of the Paris Agreement sets out that unused carbon credits from one commitment period cannot be carried over to the next commitment period. This means that Article 6 credits must be used within the same NDC cycle that they are generated in, known as the ‘no banking rule’. This applies to credits generated under both Article 6.2 and 6.4. The details of this can be found in the guidance and rulebook for Article 6 available on the UNFCCC website.
A6.4 37 points to sectoral national minimum aggregation as the lowest crediting point. Should A6.2 follow this in spirit?
Article 6 was intended to facilitate both carbon reduction and removal projects in countries. This is inclusive of cookstove projects.
It is unlikely that Article 6.2 will follow the national minimum aggregation approach. Whilst this approach may reduce fragmentation and simplify verification and monitoring under 6.4, it’s unlikely that it will be used for Article 6.2 as well. Article 6.2 was intended to be a country-led process which would enable flexibility for countries to choose the approaches and mechanisms that best suit their individual contexts and capacities. Although some level of guidance and oversight is needed for Article 6.2, it is unlikely to be too prescriptive as this may act as a barrier to countries participating.
Carbon insurance was mentioned in one of the drafts on Article 6 at COP28. What do you think is the value of having insurance in Article 6 deals? What's the likelihood that liability mechanisms, like insurance, will be mentioned in future Article 6 agreements and discussions?
Insurance will play an important role in Article 6 carbon markets and carbon markets more broadly, just as it does in financial markets. Financial markets have adopted tools such as ratings and insurance to acknowledge the risk that is inherent in the market and this needs to be done in carbon markets too. Insurance in these deals will serve to manage risks associated with project failures, such as non-delivery of promised emission reductions and policy changes that might affect projects.
Insurance in these markets is also key to building investor confidence and credibility to help stabilise the market as a whole as Article 6 negotiations continue. We will continue to see mechanisms like insurance mentioned in the documents, however it is somewhat hard to predict how these negotiations will develop.
In many cases, Article 6 projects will forward sell their credits to the buyer countries. Does this change the use case or remove the use case for ratings given that the due diligence you know should have happened?
Ratings are valuable for conducting due diligence prior to an investment, but it's not the only use case for ratings. Ratings also add value in monitoring the performance of a project and its application over a crediting period. Other use cases for ratings include reporting, portfolio management, benchmarking, risk management, and future project selection.
How could a project developer participate in the implementation of a project eligible for ITMOs? How can a developer with little or no project development experience get to grips with the procedural and legal requirements of Article 6? How can we understand how to interact with governments so we don't miss out on opportunities?
In this current state, the market is quite open to all sorts of developers. The big difference is that the transactions or selling of credits need to be government authorised. The emissions behind the ITMO that you are trading need to be added back into the emission balance of the host country and can then be taken out of the emission balance of the government on the buy side if it is for its NDC. The government needs to authorise this and it will be the one adjusting its reporting to the UN. To be successful, you have to invest in government relations, government affairs, and country-specific policy expertise. The nature of project development is changing in a sense that government affairs have become an integral part of the business.
If projects are required to use a government or new Verra baseline, and they comply, what criteria will you use to base your ratings?
BeZero Carbon will continue to assess projects in the usual way using the same key criteria, as mentioned above. Our ratings reflect our opinion on the likelihood that a credit is achieving 1 tonne of CO2e avoidance or removal and this will always guide our assessment. If a project complies with stricter guidance to set its baseline, we will still run our own analysis of how appropriate this is.
In the context of REDD, at the project level we will still assess baseline quality, using tools such as our in-house Dynamic Baseline models. We will likely also do some analysis of the broader jurisdictional baseline, looking at how it was developed, if there are risk maps or allocations involved and where these are valid, and how appropriate they are. This will then also factor into our assessment.
What are the expected dynamics between Article 6 and the Carbon Removal Certification Framework (CRCF) of the European Union?
There have been ongoing discussions regarding the fungibility and equivalence between Article 6 and CRCF credits, however it's unknown how this will develop. There does seem to be some expectation in the market that CRCF will be revised in the future to acknowledge Article 6 credits as well and look for alignment, particularly as we see countries like Sweden and Switzerland already engaging in bilateral agreements with different countries.
There are a few concerns regarding CRCF and the double claiming/double counting aspect. Currently a company could claim a credit that a host country is also claiming against its NDCs, so there do appear to be some aspects that need to be clarified in the CRCF guidance. International alignment will be crucial; there needs to be consideration of how CRCF will interact with Article 6 going forward. It’s worth keeping an eye on the developing dynamics in this area, particularly with upcoming elections and the Bonn Climate Change Conference.
What are some tools for countries to better understand the pricing they need and can get from buyers?
From the supply side, understanding the carbon cost curves in individual countries will really matter. One approach would be for cheaper emissions reductions/removals to be kept in-country, whilst those that do not factor into the country’s NDCs that are higher cost can be exported.
From the demand side, generally there's a range of factors influencing pricing, depending on the end market. Supply and demand will vary in different end markets such as CORSIA. It remains to be seen how Article 6 pricing will evolve relative to other compliance markets. We know that other factors drive price; for example, removals have traded at a premium to avoidance, sub-sectors can be in vogue, and location, co-benefit characteristics, vintages, and of course ratings all matter too.
In general, reliable price estimates can be hard to come by in the carbon market and it’s important to be aware of added complexity. Although there are pricing providers, they often rely on some element of modelling, estimates, or extrapolation in order to provide full coverage.