Voluntary carbon market players seek clarity, concrete guidelines at COP27

While the 2021 UN Climate Change Conference, or COP26, laid out landmark decisions on Article 6 of the Paris Agreement, market participants remain fraught with confusion on the intricacies around Articles 6.2 and 6.4, the application of corresponding adjustment, and the future of the voluntary carbon market as it stands today.

S&P Global Commodity Insights spoke to key players in the VCM on their expectations ahead of COP27, which will be held at Sharm El Sheikh in Egypt on Nov. 6-18.

1. A more subdued COP27

With the broader macroeconomic scenario being vastly different this year, there are fewer expectations from COP27 compared to the conference held in Glasgow in 2021. This year, understandably, players are more preoccupied with soaring energy prices.

International carbon credit certifying standard, The Gold Standard, said it is always hard to keep up momentum following a milestone conference, like COP26. "However, the planet doesn't have time for missed opportunities, so we hope that COP27 sees substantive progress in the negotiations as well as toward real-economy outcomes," said the Standard in an email to S&P Global.

2. CDM transition

While Article 6.4 provides for the transition away from Clean Development Mechanism, or CDM, participants are unclear about the fate of existing Certified Emissions Reductions, or CERs, in the market that were earlier issued under CDM. There is also uncertainty about the criterion for CDM projects that will be allowed to transition to the Article 6 mechanism.

"There is no clarity on projects that will be included in Article 6. For example, will renewables be included?" said Jatin Kapoor, head of climate transactions at Emergent Ventures India, a climate consultancy firm.

A second developer said, "There is the expectation CDM might move to SDM (sustainable development mechanism). But we don't know the nuances and how all that will happen."

3. More clarity on Article 6.2 guidelines

Article 6.2 lays down guidelines covering internationally transferred mitigation outcomes, or ITMO, between governments that are parties to the Paris Agreement. ITMOs refer to internationally traded credits between two governments. With few bilateral agreements signed, there is a lack of clarity on which mitigation activities will be covered under Article 6.2.

"We are developing several Article 6.2 mitigation activities based on our knowledge of existing carbon market-based mechanisms such as the CDM, Gold Standard or VCS," said Sergi Cuadrat, managing director at ALLCOT, a large project developer. However, Cuadrat added, Article 6.2 is a country-led approach that still needs to build the governance of cooperative approaches to undertake the trading of ITMO.

"In other words, ALLCOT is already developing projects under Article 6.2 but the lack of readiness of countries is delaying ITMO trading activity," Cuadrat said.

When asked about the expected outcome of ITMO trading on the voluntary carbon market as it stands today, Dr. Sascha Lafeld, chief carbon officer at ClimatePartner, said it would be largely dependent on whether corresponding adjustments, or CAs, are necessary for VCM use.

"At the moment, the general view of the VCM is that CAs should not be mandatory, but optional. If this remains the case, most corporate actors would likely favor 'regular' VCM credits over ITMOs, which are likely be more expensive and difficult to obtain," Lafeld said.

CA is an accounting mechanism that ensures each carbon credit is only used once. While Article 6.2 clarifies that a CA is needed any time a credit is exchanged among nations, it remains unclear whether a corporate entity and a nation could claim the same credits - with the corporate entity claiming the credit against its carbon neutral targets and a state against its Nationally Determined Contributions under the Paris Agreement - at the same time.

4. A more streamlined Article 6.4

Article 6.4 lays down guidelines for the mechanism that is set to succeed the CDM. Carbon market players say they need more clarity on the credits that would qualify under this mechanism. There is also a lack of standardization on the process for countries to issue corresponding adjustments.

South Pole, one of the largest players in VCM, says much work remains on procedures and tools for Article 6.4 to become operational, particularly in demonstrating the additionality of projects and adopting quantification methodologies.

"This work is critical for project developers to start investing in developing projects under the new mechanism," said Mireia VIlaplana, who heads the Climate Policy, Finance and Carbon Markets unit at South Pole.

5. The continuance of REDD+ projects

While the jurisdictional approach toward REDD+ projects has been gaining in prominence, there is a lack of clarity on whether REDD+ carbon projects will be allowed under Article 6.4. REDD+ is a category that has been historically mired in a debate around their suitability as a tool for emissions reduction.

ALLCOT said their interpretation is that REDD+ activities meeting all other applicable Article 6 requirements will be implicitly eligible.

"From our point of view, under Article 6.2, countries can agree among themselves on specific REDD+ guidance and approaches, particularly with regard to environmental integrity and robust accounting requirements, but it is still unclear how an ITMO from REDD+ can be accounted in a buyer country NDC with the risk of permanency," said Cuadrat.

6. Future of the VCM

There is expectation that with a more widespread implementation of Article 6.2 and Article 6.4, there will be a growth in compliance markets across countries, which might reduce the significance of voluntary carbon markets.

According to data from analysts at S&P Global, the entire supply of offsets in September from the four major registries - ACR, CAR, Gold Standard and Verra - declined by 58.6% year on year. The overall demand for offsets for the month has also declined by 0.23% compared to September 2021.

ClearBlue Markets, which specializes in low-carbon initiatives, says that in the short term they don't expect a lot of corresponding adjustments for the VCM because the benefit to the host country is unclear.

"It does not make sense for a host country to authorize the credits and do a CA unless their NDC is exceeded. We believe if there is a CA, the host country is going to want something beyond the investment in the carbon project such as cash flows beneficial broadly beyond carbon possibly in the form of a fee, transfer of technology or further investments," said Jennifer McIsaac, director of market analysis at ClearBlue Markets.

EKI Energy Services Ltd., or Enking, another large player, points out that with the market being largely unregulated, the lack of structured guidelines for corresponding adjustments leads to uncertainties in policies.

"This lack of guidelines when coupled with policy and language barriers of each nation, affects the market and the extent of collaborations that could have been possible among nations," Enking CEO Manish Dabkara said.