Carbon Markets Enter A New Era Following The COP 26 Glasgow Mechanism Agreement
On November 13th negotiators at COP 26 in Glasgow finally agreed on the key principles to shape a new UN-administered carbon market enabling international trade in carbon emission reduction credits. Looking at the Article 6.4 agreement through the lens of firms participating in the carbon market this is a very positive outcome which ushers in a new era. As Verdantix predicted in late October, carbon price indexes have increased between 15% and 25% since COP 26 started. As with any international negotiation, competing interests resulted in significant compromises on desired outcomes. What are the positives, remaining uncertainties and potential negatives?
First for the positives. The fact that an agreement has been reached – six years after the original target date – adds huge momentum to market development. The Article 6.4 agreement clarifies that host countries of offset projects will need to make ‘corresponding adjustments’ to their Nationally Determined Contributions (NDCs) when they transfer credits to another entity such as a project developer. The deal also determines which Kyoto Protocol CERs can be transferred into the Glasgow mechanism market – specifically those which were certified after 2012. The new agreement also specifies that the UN Supervisory Body needs to develop more robust rules for offset project baselines, methodologies, monitoring and reporting which should tackle the reputational problems in the market. A central, UN-administered registry for emissions reduction credits will be created. Project methodologies developed by standard setters like The Gold Standard and Verra will be used as inputs for the new UN-defined project rules. Going forward any entity – business, government or not for profit – will be permitted to design projects and seek certification by the UN body.
But uncertainties remain. Market rules will be developed over the next 12 months. There is no certainty about how stringent these rules will be given the international composition of the UN Supervisory Body. Pre-Glasgow mechanism projects will likely need to be recertified creating a risk that some projects will not be permitted to issue credits. Tougher project rules include a requirement for firms to monitor reversals in emissions reductions which will both increase project monitoring costs and potentially reduce credit issuance. As the UN registry is set up, it raises questions about the role of existing registries whether run by not for profits or by firms like IHS Markit. Post-2012 Kyoto Protocol credits can be supplied into the Glasgow mechanism market until the end of 2025. This creates price uncertainty for the next four years as there is a lack of insight into the volume of these credits.
The COP 26 Glasgow mechanism agreement also shifts the basis for running profitable offset projects. More stringent project methodologies will increase the average cost of project development and monitoring. All projects will need to contribute 5% of issued emission reductions into the Adaptation Fund. At issuance, all projects will also need to contribute at least 2% of emission reductions for cancellation as part of the Overall Mitigation in Global Emissions (OMGE) policy goal. The flow of emission reduction credits into the Glasgow mechanism market from post-2012 Kyoto Protocol projects will put downward pressure on prices and poses ongoing reputational risks.