Raising Climate Ambition – Carbon Finance Holds the Key

50.4-megawatt Tata wind farm in Maharashtra, India.
50.4-megawatt Tata wind farm in Maharashtra, India.

By Woochong Um

International carbon markets, if developed in a credible way, can play a vital role in accelerating climate action.

We are living in a key moment in human history. The recently published special report by the Intergovernmental Panel on Climate Change has amply cautioned on the consequences of 1.5ºC of global warming. Countries in Asia and the Pacific are already experiencing the impacts of climate change. There is an urgent need for the global community to act now and significantly enhance their mitigation ambitions in the spirit of the 2015 Paris Agreement on climate change.

Fortunately, there is growing momentum for using market-based approaches to meet climate targets, as countries proceed with plans for implementation of their nationally determined contributions (NDCs) under the Paris Agreement.

While there is a growing trend for establishing domestic emissions trading systems worldwide, the post-2020 global carbon markets under the realm of Article 6 of the Paris Agreement are yet to evolve and provide clear signals. But what is clear is the key difference on how markets functioned under the 1997 Kyoto Protocol, and the way they will operate under the Paris Agreement.

The Paris Agreement is leading to a fundamental shift in thinking. To take full advantage, it is imperative that Asia and the Pacific be proactive, pursue climate actions and create opportunities that support its own NDC aspirations, while bringing much-needed carbon finance that can support sustainable development.

The Kyoto Protocol provided a top-down architecture with centralized oversight where only developed countries had greenhouse gas (GHG) emission reduction targets. On the other hand, the Paris Agreement has a bottom-up structure, requiring all countries to commit to their NDCs. This country-driven approach is the key strength of the Paris Agreement, as it respects national autonomy and encourages more proactive participation by all countries.

To ease the burden of compliance, the Kyoto Protocol introduced flexible mechanisms to create a market for carbon credits, stimulated private financing and technology transfer/diffusion, and provided the institutional infrastructure for market mechanisms.

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With approximately 84% of the certified emission reductions (CERs) issued from the Clean Development Mechanism (CDM) activities hosted in the region, Asia and the Pacific is a crucial region for GHG mitigation opportunities and actions.

Despite the success of CDM, we saw what some would call a “market failure.” This was not due to a lack of mitigation opportunities or an inability to implement mitigation activities, but rather because of weak demand for carbon credits, leading to a lack of price signals – issues stemming from lack of ambition at the political level.

Consequently, despite the early gains, there has been no strong international price signal to incentivize investments in low carbon technologies since 2010-2011. The decline in the price and apparent evaporation of opportunities has also disenchanted some of the investors, as they failed to realize potential benefits they had envisaged early on.

Will this change with the Paris Agreement?

Article 6 allows countries to collaborate in achieving their NDCs through market and non-market approaches. It also establishes a framework that provides the foundation for the resurgence of international carbon markets through cooperative approaches involving international transfers of mitigation outcomes, as well as a new mitigation and sustainable development mechanism, both of which provide the basis for using carbon markets and climate finance to reach national climate targets toward the Paris Agreement’s goals.

The use of market-based approaches under Article 6 has strong international support. Countries believe that international collaboration can make it easier to meet their NDC commitments and encourage them to be more ambitious. At the same time, under Article 6 host countries have a larger and more important role since they only have an incentive to export carbon credits that do not undermine achieving their own NDCs.

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A key component will therefore be how countries can use Article 6 strategically. Article 6 can complement domestic climate policies. This means that the potential use of Article  6 mechanism(s) can be very different in different countries, depending on the domestic climate policy landscape.

Article 6 could be a tool for identifying and bridging policy gaps, mobilizing private finance to identify cost-effective mitigation opportunities. Its framework and infrastructure will form the basis for serving climate finance and tracking NDC implementation and achievements.

With the possibility of tailoring approaches under Article 6, countries can use market mechanisms to go beyond mobilizing carbon finance and facilitate climate finance, providing a broader palette of instruments. This is likely to be necessary so the development of the post-2020 markets gives countries time to understand how they can use Article 6 for NDC enhancement.

Market-based cooperation is key to promote cost-effectiveness and flexibility of mitigation actions. It is estimated such cooperation could reduce the global cost of delivering the current NDCs by about 30% by 2030 and more than 50% by 2050, compared to a scenario without international collaboration.

For many years, market-based approaches have focused on emissions trading and the project-based baseline/crediting approach, such as the CDM. These have provided valuable lessons and experiences for the future.

However, the disaggregated structure under the Paris Agreement, coupled with the objectives of scaling up mitigation action and raising ambition, would equate to a much wider range of mitigation activities covered by Article 6. These could range from small-scale individual projects to sectoral mitigation actions involving carbon pricing and carbon crediting.

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The push for a new approach to mitigation activities under the Paris Agreement should drive greater demand for GHG emissions reductions, providing scope for further innovation and above all, cooperation among countries to achieve their respective NDCs. It is also an opportunity for countries to identify and structure mitigation activities that suit and contribute to their national priorities.

The all-important involvement of countries in the Asia Pacific will likewise lead to a more integrated approach to carbon finance and the underlying finance for mitigation actions. In turn, countries could be rewarded with carbon revenues and sustainable development co-benefits like enhanced energy access, better health, infrastructure development, job creation, and women’s empowerment, among others.  

Finally, a comprehensive cooperative build-up of the post-2020 markets could facilitate diffusion and transfer of advanced low-carbon technologies that still come with high costs and face other barriers.

We expect Asia and the Pacific to remain a focus region for mitigation actions since it is fast-growing and accounts for a large share of global GHG emissions. Asian countries could be both supply and demand centers, thus not entirely relying on demand from external sources. In the longer term, a regional emissions trading system could spur demand for international emission reductions in the region.

Moreover, based on the NDCs and ongoing discussions among countries, it is reasonable to expect growing demand for carbon credits and an active post-2020 international carbon market. The ratcheting-up process of the Paris Agreement is expected to call for more ambitious targets, not least for the developed countries.

Climate action, including the development of the future carbon markets, is now in the hands of all countries – including ADB’s developing member countries. International carbon markets, if developed in a credible way, can play a key role in accelerating climate action, which is paramount for sustainable development in the region.