Delegates at the COP24 annual UN climate conference in Poland in December agreed on large parts of the Paris Agreement “rulebook,” the operating manual needed for when the global deal enters into force in 2020. However, a key unresolved agenda item was postponed until next December’s COP25 conference in Chile:  to discuss and agree on the rules that will govern the “next generation” of carbon markets for the trading of carbon emission allowances.

Damaged by the global financial crisis and carbon credit import restrictions, carbon prices collapsed in 2012, when supply far exceeded demand and the world community was unable to agree on a framework for climate policy after 2012.

The Paris Agreement has now re-ignited interest in carbon markets.

Key issues

Read the Report
Carbon Markets for Greenhouse Gas
Emission Reduction in a Warming World

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The main issues still to be resolved concern rules for voluntary market mechanisms under Article 6 of the Paris Agreement. This includes Article 6.2, under which countries can trade overachievement of their pledges to curb greenhouse gas (GHG) emissions, as well as Article 6.4, under which individual projects can generate carbon credits for sale.

Article 6.4 is intended to replace the “Clean Development Mechanism” (CDM)—the world's only global system of carbon trading—which was established under the Kyoto Protocol, the precursor to the Paris Agreement. The CDM was also designed to benefit developing countries, because it allowed developed countries to source and buy credits from these countries derived through eligible low-carbon investments.  Under the CDM, the primary carbon market ballooned from US$2.47 million annually in 2000, to US$7.9 billion at its height in 2007, according to a recent report by the World Bank Group’s Independent Evaluation Group on Carbon Finance.

How Carbon Markets Contribute to Emissions Reduction

There are two ways to motivate firms to cut their GHG emissions: carbon taxes, which provide a direct incentive to reduce emissions, and carbon markets, which help reduce the cost of meeting emissions reduction targets, and thereby provide an indirect incentive to meet the targets.

For carbon markets to play their role as a tool for climate mitigation, there needs to be predictable demand for low-cost carbon credits. When there is no demand for carbon credits, there will be no market for generating and supplying these credits.

Under Kyoto, carbon markets worked when developed countries had (1) clear and binding commitments to reduce emissions, and (2) the political willingness to import the cheaper credits from other countries. Through the “flexible mechanisms”, the international carbon markets facilitated the transfer of cheaper credits from developing countries and transition economies to help developed countries meet their targets at lower cost.

Following the collapse of the international carbon markets in 2012, some countries have moved towards establishing domestic markets which may not allow imports of any foreign carbon credits. While domestic markets are relevant, mitigation efficiency might be limited when such markets to do not allow international transfers and countries with lower costs to supply the credits, and therefore emission reduction costs may remain high – limiting the potential to raise the mitigation ambition.

The World Bank Group was one of the first movers and a key player in creating the carbon markets under Kyoto, starting in the late 1990s. Overall, IEG has found that the World Bank Group’s experience under Kyoto affirms that carbon markets can play a critical role in stimulating low-cost climate mitigation and support clean and green investments in developing countries.

IEG held a panel discussion on Feb 5, 2019 about the Future of Carbon Markets for Climate Change Mitigation
Watch the re-play of the live event.

How the Next Generation of Carbon Markets Can Become More Effective

The current need for piloting and demonstrating the market mechanisms under the Paris Agreement echo the early period of Kyoto Accord.  Countries, international organizations, donors, and the private sector can leverage their comparative advantages to revitalize the carbon markets and facilitate this transition and to support greater emission reductions, consistent with the high ambition of the Paris Agreement.

Key issues to consider for the future of carbon markets, based on the Kyoto experience, include the following:

For the greater climate policy and carbon finance community

  • Reduce policy uncertainty. The next generation of carbon markets need to be built on a stronger foundation and policy environment from the past. This requires policy clarity, stable and higher prices, and predictable and longer-term demand for emission allowances.
  • Improve efficiency and transparency of regulatory systems. The project cycle and the regulatory process under Kyoto has been criticized for being lengthy, costly and unpredictable, which increased the transaction costs and the project risks for investors in low-carbon alternatives. Learning from the Kyoto experience, better standardization of the validation, monitoring and verification systems are key to improve transparency and legitimacy of the regulatory system.
  • Attract and leverage private investments to scale up climate change mitigation. In addition to rebuilding trust in markets, incentives for the private sector are stronger when carbon finance improves the returns and bankability of the investment (for example, when frontloading of carbon revenues is possible to secure the financial closure of projects).

For the World Bank Group

  • Mainstream carbon finance with development and climate finance to support transformational change. This requires going beyond trust-funded, project-focused and small-scale activities to scale up emission reductions and to raise ambition. The uptake and integration of carbon finance with other World Bank Group instruments and operations can be enhanced by improving internal coordination and moving toward larger project funding with lower transaction costs.
  • Link climate mitigation through carbon finance with development and environment benefits. The additional benefits (co-benefits) add incentives for client countries to use carbon finance for climate mitigation. Development co-benefits include greater access to clean and affordable energy and reduced poverty, and environment co-benefits include reduced pollution and improved health.
  • Revitalize, stabilize and expand markets targeting new opportunities. The World Bank Group can leverage its accumulated experience, expertise, financing instruments and thought leadership from the Kyoto period to inject new momentum and help revive the carbon markets. Stronger leadership would be key to innovate, catalyze and deepen markets and to reduce market risks, especially in underutilized sectors and underserved regions and countries.

Read the Report: Carbon Markets for Greenhouse Gas Emission Reduction in a Warming World

Comments

Submitted by Antoine Kantiza on Tue, 02/05/2019 - 12:23

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Essay of an authentic International Carbon Market
After Kyoto protocol of United Nations Framework Convention on Climate Change signe on 11th December 1997 which entered into force on 16th February, 2005, the Paris Agreement of UNFCCC signed on 12th December 2015 has the advantage of improving the sustainability of long-term demand of carbon credits on the international carbon market and emphasized the Nationally Determined Contributions for reaching the carbon emission reduction in order to stabilize the warming of the world without allowing the increase of two degrees Celsius.
Undeniably, the international carbon market has already showed its failure during 2012 when happened the lack of demand of carbon credits together with the global over warming of the whole planet.
By the way, it is well known that an international economic market is a free real or virtual palace of goods’exchange where economic actors could generate income. Nevertheless, any economic market could be volatile as well as being uncertain. Frankly, the international carbon market is characterized by its volatility and risks alike the climate change without having the same probability of occurring in the same moment such as the global warming of 2012. The international carbon market has its inherent difficulties of being boycotted somewhere by some great countries of economic market based and has no autonomous demand and supply of carbon credits as instruments of finance on the international level.
Indeed, an authentic economic market is a palace where the curbs of demand and offer of goods could cross freely what is not the case until now for the international carbon market despite the article 6 of Paris Agreement.
The current viability of domestic carbon market is due to the impacts of national law enforcement for externality costs which used to be paid as taxes by national enterprises or industries involved in greenhouse gas emission during their production process meaning that the domestic carbon market is not a true economic market but a substitute of taxes paid for carbon externality costs in the line of the Nationally Determined Contributions for carbon emission reduction..
I think that the solution for reaching the stabilization of climate change will be reached as soon as the enforced rule will be applied on the international level and verified more likely towards the Nationally Determined Contributions than by the international carbon market where only free economic actors should sell or buy carbon credits and so on voluntary basis.
Also, I think that it is mandatory to establish a International treaty of Regulation of Greenhouse Gas Emission by catalyzing all rational mechanisms of preventing climate change including carbon finance instruments, promotion of clean and green investments as well as innovation in the production process mitigating the emission of greenhouse gas all over the world.
Besides, the rule guiding the Montreal protocol on Substances that Deplete the Ozone Layer signed on 26th, August 1987 remains the best way to follow for carbon and other gases emission mitigation in order to prevent efficiently the greenhouse gas emission, the global warming and the instability of climate change on the whole planet.
Antoine Kantiza,-
Bujumbura-Burundi on 5th February, 2019

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