There are two main ways to deliver carbon emission reductions in order to combat climate change:
1. Measures along the company‘s own value chain
2. Measures outside of the company‘s value chain, to compensate for emissions that remain unabated within the company‘s own value chain.

Carbon Markets: Mandatory vs Voluntary

Such compensation measures are referred to as carbon offsets and have been around for more than 20 years. However, in the phase of the recent 26th Conference of the Parties (COP26) to the United Nations Framework Convention on Climate Change (UNFCCC), the discussion about the relevance of carbon offsets has picked up speed again.

Generally speaking, carbon markets have arisen from the trade of carbon offset credits, which are market-based instruments that assign a monetary price to carbon. In the eye of combating climate change, carbon offsets have been promoted as an important part of the solution. This can be drawn back to their economic and environmental efficiency and the potential to deliver social, economical and additional environmental co-benefits through technology transfer and capacity building.

Two types of carbon offsets can be differentiated: mandatory and voluntary carbon markets.

Mandatory markets follow the set requirements of governments, which oblige certain organizations to participate. Those compliance carbon markets were, for instance, created under the Kyoto Protocol and the European Union’s Emissions Trading Scheme and set a “cap” that presents the allowable amount of emissions to be emitted by country. This cap requires nations and thus organizations that exceed the limited amount of carbon emissions to offset through the trade of carbon credits.

The voluntary carbon market enables companies to purchase carbon offsets on a voluntary basis with no intended use for compliance purposes. Voluntary carbon trading is widely considered as crucial in order to reduce CO2 emissions because it enables the investment in emissions-reduction technologies.

The conversation at COP26

In the carbon markets debate at COP26, the main focus was put on Article 6 of the Paris Agreement. The article introduces provisions for using international carbon markets to enhance the fulfilment of the so called Nationally Determined Contributions (NDCs). As the NDCs represent the non-binding plans of single nations, highlighting climate actions and thus nations‘ means of carbon emission reductions, the discussions in Glasgow were mainly centered around the mandatory market. Nevertheless, implications for the voluntary carbon market can be derived.

Decisions at COP26 on the mandatory carbon market

The resolution to launch a new crediting mechanism. This would grant all countries, which are interested in attracting investments which reduce carbon, the possibility to trade carbon credits through the UN-certified global carbon market.

The revised Article 6 of the Paris Agreement, now provides clear accounting guidelines for the compliance markets. With the new rules set, the trading of emissions between countries is regulated and one of the main pain points, which is double accounting, can be avoided. Double counting refers to the situation where two countries, or more generally speaking, two parties, claim the same carbon removal or emission reduction. The issue of double counting from now on will be addressed by the means of “corresponding adjustments” of national carbon inventories. This means that if one country uses a carbon offset to reduce its carbon footprint, the credit cannot be claimed by another nation. Thel Article 6 rules thereby allow the nation, which is hosting the offsetting project, to make the ultimate decision whether the emission reductions will be counted towards its own targets or sold to another nation. In any way, the country hosting the offsetting project has to notify a UN supervisory board.

Implications of COP26 for the voluntary carbon market

Even though the voluntary carbon market will not be directly regulated by Article 6, experts say that the provided accounting adjustments may bring increased transparency and thus support the quality of voluntary offsets offered. This is extremely important, as the voluntary carbon markets are currently growing at a fast pace, which makes it more difficult to oversee.

The COP26 decision leaves it to the nations themselves to decide whether emission reductions through voluntarily purchased offset credits can be used towards a country‘s NDC. However, for a voluntary emission reduction to be finally counted towards a country‘s NDC it must also be authorized by the UN. Following the new rules set out to avoid double counting, the offsetting project host country also has to apply a corresponding adjustment for any voluntary carbon offset credit sold.

Optimists say that the COP26 decisions will accelerate the expansion of the voluntary carbon markets due to higher investments in carbon credits and an increased demand for such credits. The increasing demand in turn will boost the values for carbon offset credits, which helps to get more ambitious offsetting projects started. Ultimately, this will support governments and businesses in reaching their climate targets.

Nevertheless, the clear guidelines, which leave less room for poor-quality offsets and aim to prevent double counting, could help us to cool the planet, skeptics are still cautious about whether the COP26 decisions actually will lead to climate benefits.

The shift in the voluntary carbon offset market

Through the decisions made in Glasgow, it becomes clear that next to traditionally accepted carbon offset projects, investments in the development of innovative carbon capturing technologies for instance, which serve the purpose of offsetting carbon emissions in the long run, will become more attractive. Experts claim that voluntary carbon markets have already topped the value of 1 billion USD in 2021 and are expected to further grow.

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Text by Sophie Weresch, ClimateTech at Cozero

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