Dealing with corresponding adjustments under Article 6.4 of the Paris Agreement

This proposal is a response to the need for political compromise on the accounting of emission reduction units generated by the CDM and the mechanism that is being created under Article 6.4 of the Paris Agreement. As visualized by the graph, the proposal is to define a transition period that evolves from simple accounting of transfers to full corresponding adjustments. Such a transition would allow countries to adjust to a new regime of comprehensive accounting, recognize and expand early action and build the domestic policies and capacities that are needed to effectively manage, and account for, mitigation activities that are developed under their NDCs.   

Please Note: This is an ad-hoc attempt to support the ongoing discussion with a constructive proposal. While the text is my sole responsibility, the objective is to build common ground on the basis of diverse stakeholders input, rather than expressing my own opinions and preferences. As discussions continue, the text is subject to change as I will seek to address constructive comments or proposals.

Context and the challenge at hand:

The development of rules for the implementation of collaborative approaches defied by Article 6 of the Paris Agreement are a key objective of the ongoing negotiations at COP 24 in Katowice. Many share the view that the implementation of effective carbon market instruments, as defined by Article 6, are the key to a global net zero carbon economy. The argument is that the sum of individual contributions made by parties will not suffice, but that sound cooperation allows to increase ambition by minimizing global costs and mobilizing capital that is needed for transformational action in developing countries. The Environmental Defense Fund illustrates this argument by showing that sound global carbon markets allow to increase GHG mitigation efforts by 40%, without generating additional costs for the global economy. Of special relevance in this discussion is the possibility of engaging private sector investors, an opportunity that arises under Article 6.4, and that builds on the concepts and experiences of the Clean Development Mechanism (CDM). In addition, Article 6.2 defines provisions for the development and transfer of Internationally Transferable Mitigation Outcomes (ITMOs). The Paris Agreement defines ITMOs as transactions that are directly managed by governments and that are subject to full accounting of international transfers. The concept was dubbed corresponding adjustments, a term that describes the double book keeping of ITMOs transacted between parties. Yet, the provisions for accounting of Article 6.4 transactions are subject to specific controversies. The intention of this text is to elucidate critical aspects of the discussion, as well as to develop a proposal for a political compromise.

Before entering the discussion, it is important to remind that Article 6.4. evolved from a proposal on the creation of the Sustainable Development Mechanisms (SDM), that was made jointly by Brazil and the European Union. In simplified terms, the SDM is an evolution of the CDM, with reinforced focus on sustainable development outcomes, the objective of increasing ambition, as well as the requirements for some form of accounting of generation, transfer and use of the emission reductions units that arise from the mechanism. Even after revising the now updated negotiation texts on Article 6.2 and 6.4, that were released by the COP presidency on the afternoon of Thursday 13 of December, it is apparent that countries are still struggling to define several critical elements, including two major obstacles:

1)    The definition of rules and provisions that allow the transfer of CDM projects and their achieved and future emission reductions;

 2)    The definition of accounting rules to satisfy requirements of environmental integrity. 

Both issues are intrinsically related, as we can see from analyzing the concrete case of Brazil, which is a key actor in the negotiation of this mechanism. Now in spite of this specific perspective, comments and insights may easily be transferred to other emerging and developing economies.   

The future of the CDM from the perspective of Brazil’s GHG policy and experiences

Brasil is one of the few developing countries with an absolute GHG emission target for 2025: The objective of reducing emissions to 1.3 billion tCO2e was calculated as a 37% GHG reduction in relation to the 2005 base year. In other words, Brazil has committed to reduce its GHG emissions by a total of 760 million tCO2e. Moreover, Brazil indicated to further reduce its emissions to 1.2 billion tCO2e by 2030.

While this GHG mitigation is the result of predominantly domestic efforts, Brasil has a comprehensive strategy to engage and work with international support mechanisms. In order to reduce deforestation, Brasil receives substantial donations from countries such as Norway and Germany. While this support is instrumental, it is fair to argue that domestic policies and efforts in terms of command and control, that imply substantial economic and political cost, were the decisive factor.

The energy and industrial sectors are another focus of Brazil’s climate policy. Given the fact that GHG mitigation in these sectors is very capital intensive, Brazil established a policy to use the CDM in synergy with domestic carbon finance solutions as well other regulatory support policies. This strategy was reinforced in preparation of COP 15 in Copenhagen and later consolidated in Brazil’s Nationally Appropriate Mitigation Actions (NAMAs). As a result of these efforts, investors engaged in substantial GHG mitigation investments during the Kyoto Protocol’s first commitment period. Based on the CDM’s comprehensive baseline and monitoring methodologies, the estimate is that the total potential in annual GHG emission reductions generated by CDM registered projects is in the range of 50 million tCO2e per year and that a total investment of 32 billion USD has been promoted.

Unfortunately, due to the default on the expectation for substantial participation and GHG mitigation under the Kyoto Protocol’s second commitment period, demand and prices for GHG emission reductions disappeared after 2012. As a result, more capital intensive and structural GHG mitigation activities, that take time to develop, did not obtain any reward for their efforts. Considering the requirement that projects can only be registered under the CDM if they demonstrate a lack of economic viability, this situation rather amplified than mitigated Brazil’s economic and political problems.

From the perspective of the current discussion on the future of international carbon market mechanisms, it is clear that Brazil’s GHG mitigation effort, especially when related to the structural mitigation of long-term infrastructure investments, contributed to the GHG reduction trajectory that supports Brazil’s NDC. Based on the mentioned figures, the CDM supported about 6% of Brazil’s mitigation effort as necessary for the 2025 target. So far, these efforts did not obtain the international support and compensation that was defined under the provisions of the Kyoto Protocol as less than a year worth of emission reduction units has been transferred to international buyers. 

The legitimate concern therefore is that a full consolidation of these results in Brazil’s NDC, without options to transfer these projects and their mitigation results to the future global climate regime, would imply that these domestic efforts and the early action results are being ignored.

The importance and challenges of sound accounting rules to create effective carbon markets:

The fact that the current negotiation text on Article 6.4. is largely based on the CDM illustrates the importance of the original mechanism. At the same time, it reminds us that a sound understanding and accounting of international transfers is essential to avoid criticism and ensure sustainable demand. For this reason, many actors are calling for provisions of corresponding adjustments not only for ITMOs, but also for transfers under the Article 6.4 mechanism. 

Now when analyzing the original Article 6.4, provisions for accounting are weaker than those that were established for Article 6.2. In fact, paragraphs 6.4 (b) and (c) convey the concept that the mechanism supports mitigation in the host country. Moreover, according to Article 6.5, as long as mitigation results are not used by the host country to demonstrate achievement of its NDC, the resulting units may only be accounted for by the party that acquires the resulting mitigation outcomes.

The wording seems like an example of carefully drafted constructive ambiguity that may have been necessary to conclude the negotiations in Paris, but now, in Katowice, the issue will have to be solved in a constructive manner to establish the fundaments for real action. Brazil, one of the proponents of the SDM that resulted in Article 6.4, has peen particularly vocal in objecting to comprehensive corresponding adjustments, while defending that the projects mechanism defined under Article 6.4 shall either support countries in their NDCs, or promote projects with challenges that go beyond the means of NDC policies. 

It is therefore worthwhile to reflect on the reasons an argument behind these positions to identify ground for compromise:

1)    Recognition of early action:

While it is not yet clear how and to what extend the CDM will be transferred to the new Article 6.4 mechanism, its rules will apply to any CDM project or emission reduction that is transferred. For this reason, any accounting regime adopted for Article 6.4 will impact the status of recognition of these early actions, as already explained above. In the case of full corresponding adjustments in transfers and limitations for banking, the efforts and results of these early actions would simply be consolidated in a country’s NDC. While this will hardly be acceptable for most developing countries, it would also materialize a risk for investments in mitigation actions that depend on similar support mechanisms in the future. 

 2)    Difficulties in national accounting and consolidation risks:

Any material GHG mitigation activity developed in a country will also contribute to a reduction of its national GHG inventory. Unfortunately, methodologies for project based accounting and national GHG inventories are different in ways that are not fully understood at this stage. Many make the argument that project baselines under the CDM are conservative. As a result, CDM projects may generate GHG reductions for the national inventory in excess to the credits that they receive. Nevertheless, it will take some time until this relation is clearly established for different technologies and methodologies, so that countries can manage and fully account for the effects of projects that are being developed within their NDCs.

 3)    The necessity to establish long term GHG management policies

The attractivity of a sound international carbon market with due accounting and corresponding adjustments offers the attractive possibility to establish forward sales arrangements that can mobilize the capital to finance the necessary GHG mitigation investments. Without such levers, such projects are hard to implement, especially in countries with financial constraints. While this is an appealing logic that could allow transformative action with GHG mitigation benefits beyond a countries NDC commitment, it is also evident that such a strategy requires the capacity for comprehensive long-term planning and sound management of a country’s GHG inventory. Again, this is possible and ultimately the key to increasing ambition, but the development of such practices and the necessary infrastructure takes time, and therefore it is understandable that some countries refrain from a very rigid accounting system at this stage.

 Possibilities for common ground: 

In the search for common ground, parties should recognize the structural importance of ample and efficient carbon markets at national and global level and that private sector engagement is crucial to mobilize the capital that is needed. To ensure the necessary scale and success, it is obvious that sound accounting is necessary. Nevertheless, it is also important to recognize, and further promote, early action and to offer an appropriate transition period that allows countries to build capacities. The goal of the transition period should be to ensure a swift, but consistent evolution from the carbon market logic of the Kyoto Protocol, which is technically valid until 2020, to the new market regime that will start in 2020 and relates to the NDC commitments of 2025. In order to align these objectives, the following conceptual elements could be helpful: 

 1)    The definition of a transition period:

Wile international carbon market mechanisms are a powerful tool to support or deepen the ambition of NDCs, it is important to recognize that the development and crediting of projects, programs or other activities under an NDC is subject to a set of complexities that have to be addressed with sound regulation and capacity building. It is therefore rational to establish a transition period that allow countries to evolve from simple reporting of exports to full corresponding adjustments of transacted emission reduction units. While the date is subject to the political debate, the minimum period for transition can be set for 2025, while the latest date to agree to full corresponding adjustment should be 2030. In the graph that has been elaborated for illustration, a transition period up to 2030 is being adopted.

 2)    The recognition of early action

It is essential for countries that have developed CDM projects to ensure that their efforts and results are recognized as early action so that they can also reward their investors according to terms that are compatible to the original conditions. At the same time, it is important that CDM activities are re-accredited according to rational and efficient rules and procedures to ensure the creation of a homogeneous market. Ideally, this is done together with the extension of the projects’ crediting period in order to minimize costs. Ideally, reformed CDM projects shall be subject to the same rules and procedures as other projects developed under article 6.4, providing these rules are broadly compatible with the conditions offered to investors by the CDM and under the original letters for host country approval.

 3)    Market status and use of emission reductions

During the transition period, emission reductions generated by reformed CDM, as well as new Article 6.4 projects do effectively represent a support to the implementation of the host country NDC. In cases where this leads to overachievement, this should be seen as a welcome ground for enhancing the ambition of the NDC and any volume that has been transferred should be discounted from the available volume for ITMOs to avoid the double crediting of emission reduction that may occur if a country goes beyond its NDC commitment. If countries prefer, or in the absence of international demand, they shall be allowed to bank the emission reductions generated from early action and carry it over for compliance with their future NDC commitments. Such a flexibility mechanism would not only support early action, but also accommodate concerns with compliance to NDC commitments, a fact that can support the definition of more ambitious targets.

Final comments:

Within the scope of this text it was not possible to address all elements of such a proposal. Especially the effects on different types of NDCs requires attention. Such reflections are best undertaken by professionals and experts that are aware of these different realities and I would welcome their constructive comments. Moreover, I do recognize that this discussion is subject to strong ideological controversies and I invite readers to understand this text as a pragmatic proposal for a political compromise. The objective is to trigger pragmatic progress towards increasing ambition and the market framework for deep GHG mitigation and thorough accounting that is needed.