Note: Technical terms are marked with a * and explained briefly in the Glossary.
2017 is going to be a busy year for anyone involved in the carbon markets called for under the Paris agreement. So says Dirk Forrister, President of the International Emissions Trading Association (IETA), the Geneva-based, 150-strong organisation for companies involved or interested in global carbon trading. Members include many of the world’s largest corporations, both in the OECD and outside.
“It’s going to be a really important year for China, obviously,” Forrister notes, “with its national trading scheme due to kick in. The EU has also been strengthening its Emissions Trading Scheme (ETS), and we expect a final deal on that this year. In North America, the present California/Quebec trading system will expand to include Ontario. Mexico is gearing up its cap and trade* activities, hoping to be a part of that scheme in due course, though that requires a legal package to be put in place.” Mexico is also involved in roundtable discussions with Peru, Colombia and Chile on a South/Central America trading scheme.
“We ourselves at IETA are very busy on aviation, working with International Air Traffic Association on a series of workshops for the sector, at which we plan to share experiences of emissions trading with airline representatives who may not have yet encountered carbon markets. We are also going to be busy in Washington DC, working to understand the new administration’s position on issues such as the future of the the Clean Power Plan and the Environmental Protection Agency.”
Emissions Trading and the NDCs
Last but not least, there will be a lot happening in the UNFCCC process, Forrister says. “We have quite a big role in feeding in private sector inputs to that process, and though decisions won’t be made until 2018, we expect there to be a lot of progress on Article 6 of Paris at the mid-year and COP meetings in Bonn this year.”
The Article 6 he refers to is the section of the 2015 Paris agreement that calls for the establishment of a global price for carbon and the establishment of mechanisms to trade carbon-related instruments. IETA has published a useful ‘entry-level’ guide to this topic, sometimes seen as arcane, but nevertheless vital to the Paris outcomes.
“90 INDCs mention the use of carbon markets,” Forrister says, “and in many cases at least part of their commitment is conditional on having access to these markets.” Conditional or not, Forrister explains how the markets can help propel the implementation of NDCs by providing finance that may otherwise be hard to come by, and in ways that target the most cost-effective carbon reduction strategies.
“Let’s say Countries A and B each commit to reduce their carbon by 100 units as their contribution to Paris,” he begins. “Country A is already quite clean, so it knows that to achieve this new level, it will probably need to purchase some of those units. Country B isn’t so clean, so it can probably make a reduction of 150 units if it has the money to finance a more ambitious clean development strategy. It therefore makes sense for Country A to be able to buy those extra units from Country B, and that’s the market that needs to be created.” He mentions Canada as an example of a ‘Country A’, whose NDC commitment can only be met by external purchases.
Borders aren’t really important
These types of arrangement don’t need to be made just at national levels. “Borders aren’t really important. These arrangements could be made between high-emitting sector players as well,” he says, citing industries such as power, cement, refining, aluminium, and glass. “What we need to create is commonly agreed benchmarks, so that these sectors can trade among themselves.”
Metrics and accounting are needed for the NDCs too, both so that the effects of carbon trading can be measured in terms of meeting NDC targets, but also to avoid double counting (in the theoretical scenario above, for example, it would be important to know that Country B was meeting its agreed 100 units before selling the excess to Country A).
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IETA’s guide to Article 6 posits three basic “archetypes” of NDC, at different levels of advancement in terms of the kind of commitment made and the identification of tradeable carbon.
- ‘Type 1’ NDCs are where a specific emissions target has been set and there is a reporting system already in place that could incorporate carbon unit trade. Examples of such NDCs are the EU, the US, Brazil and Japan
- ‘Type 2’ NDCs use measures such as reductions against ‘business as usual’. Countries may not have a robust GHG inventory, so national-level trading may not be possible initially, but sector-based trading may be. Examples include China, Korea, Mexico and Indonesia
- In ‘Type 3’ NDCs, commitments will be more action-based, for example in forestry or energy efficiency projects, with a commensurate need to operate at the project level, perhaps with credits-based schemes*. Example of this type are Uruguay, Samoa and Bolivia
While by no means exact, this typology, Forrister says, can help markets to draw connections between countries of a similar type and help quantify progress.
There will need to be some international standards through the UNFCCC
In its inputs to the UNFCCC process and generally, IETA is advocating a fairly broad-brush approach to the design of carbon instruments, while not compromising on accounting and especially the need to be able to spot double-counting. On market co-ordination, Forrister says that “we expect that countries can and will establish their own carbon markets, but that when it comes to linking markets across borders, and to verifying and reporting national outcomes, there will need to be some global standards set by the international community working through the UNFCCC.
But he also sees a developing role for the private sector. “For example, as well as reporting to the UN, some of the major trading jurisdictions will produce their own reports, and there will need to be micro-level checks on crediting mechanisms and so on. These kinds of services will probably be provided by private suppliers.” (This is a similar dynamic to the one we pointed out in our recent post on the green bonds market, with global and national standards interpreted by, for example, providers of ‘second opinions’ on these bonds.)
‘Big Tent’ Approach
This ‘big tent’ approach to carbon mechanisms would see trading at every level from the global to the national to the individual project. An example of the first level is the World Bank’s ‘Pilot Auction Facility’, which will make results-based investments in mitigation projects using the proceeds of bonds issued with a guaranteed floor price on carbon credits for investors. The Facility will allow such investors to make a profit if the price of carbon increases, while insuring their downside.
At the national level, Forrister continues to see bilateral arrangements by countries such as Norway, to purchase credits under REDD+* and similar schemes, as an important contributor, as well as voluntary schemes at the project and company level.
He also see the development of the carbon markets as very much in keeping with the trend towards disclosure on climate risks, where the pressure on major companies has recently been ratcheted up by the draft Task Force on Carbon-related Financial Disclosures (TCFD) guidelines. “Companies that have banked carbon credits are going to be seen as prudent,” Forrister says. “For major brands, this kind of evidence of a long-term strategy on sustainability is also going to be important from a consumer point of view.”
Membership is being built out, especially in China, Korea and Mexico
IETA’s membership is currently very heavily weighted to North America and the EU, but Forrister says that the spread of members is widening all the time, with major companies in China, for example, recently joining. In part, this has been a result of IETA’s main focus in terms of capacity building, its Business Partnership for Market Readiness (B-PMR), launched in 2012. The B-PMR works with host governments, the World Bank and donor countries, but essentially has a peer-to-peer approach, giving companies in target countries such as China, Korea and Mexico, access to the shared experience of their counterparts in more mature carbon marketplaces.
IETA also plays a commercial role in the development of markets by bringing participants together on ‘bread and butter’ issues such as the establishment of model contracts for trading instruments.
Save the Date: Barcelona
A big event milestone for IETA will take place in late May in Barcelona. Forrister explains: “IETA and the World Bank have been partners for more than a decade in the successful Carbon Expo series of events, which gather market practitioners from around the world. For 2017, we are collaborating on launching a fresh event concept called ‘Innovate4Climate 2017’ (22-26 May, Barcelona).
“To date carbon markets have often worked independently of climate finance. The Innovate4Climate format will bring these two strands together to deepen the link between them, and gather the strength of public and private capital in support of the world’s climate goals.”
Dirk Forrister is CEO and president of the International Emissions Trading Association (IETA). He previously served as managing director at Natsource LLC, the manager of one of the world’s largest carbon funds, and served as chairman of the White House Climate Change Task Force in the Clinton Administration during the Kyoto Protocol negotiations. Forrister also served as energy program manager for the Environmental Defense Fund.