Was 2022 the beginning of the end for ‘junk’ carbon credits?

Pictured: Young trees used as part of a planting scheme

The outcomes of the COP27 climate summit in Egypt in late 2022 were mixed, with many commentators arguing that nations failed to show enough ambition to accelerate efforts to deliver net-zero despite welcome progress on loss and damage.

Beyond the big, top-line visions agreed upon by nations, the COP also played host to continued discussions designed to flesh out details on Article 6 of the Paris Agreement – the part of the accord ‘rulebook’ pertaining to carbon markets and credits. Article 6 covers both “compliance” markets, enabling nations to trade emissions credits garnered from reduction and removal activities with each other (under Article 6.2), and “hybrid” national-private markets, enabling countries to sell credits to businesses (under Article 6.4).

Article 6.2 is gradually replacing the existing Clean Development Mechanism; nations have been trading carbon credits for more than a decade already. But whether this has actually led to anywhere near the stated level of climate benefits is debatable.

The Energy and Climate Intelligence Unit’s climate and land programme lead Matt Williams tells edie that the Clean Development Mechanism has around 4.2 billion credits in it, each equivalent to one tonne of CO2. He explains that the majority of these credits – around 3.8 billion – are “‘junk’ credits that aren’t worth very much”. Worth is poor in both carbon terms and cost paid – typically around $1 for each ‘junk’ credit, compared with at least $20 for a higher-quality credit.

Persistent problems that could render credits ‘junk’ include double-counting; accounting for activities that do not result in additional or permanent emissions avoidance or sequestration, and getting the ‘vintage’ of credits right. The term ‘vintage’ refers to the timeframe in which the emissions reduction or removal takes place; you cannot plant a sapling today and immediately assume the benefits of a tree that has stood for decades.

Williams tells edie that all of these issues are still pertinent, but that most credits created after the Paris Agreement was ratified in late 2015 have “much higher scrutiny”. This is because, unlike their predecessors, they count towards nations’ Nationally Determined Contribution commitments through the UN. Similarly, Standard Chartered’s head of carbon markets Chris Leeds noted a particular increase in credit quality in 2021 and 2022 when speaking with edie.

However, another issue is emerging. Williams argues that we are “at a headline level, on the same path as post-COP26 – to a system or market framework that bakes in more secrecy and potentially risks carbon credits not being worth that much.”

The secrecy part bears exploring. Williams observed that the language currently on the table under article 6.2 “allows countries to be as secretive as they want to about the credits they trade with one another”. He elaborated that, due to amendments led by COP28 hosts Saudi Arabia, national governments “can deem any information confidential, and they don’t even have to explain why. They are encouraged to, but it’s not required”.

Nations arguing in favour of the amendments stated that they would be necessary on national security grounds. The rationale is the governments may use their defense sector to generate credits, or purchase credits to apply to this sector. It is clear how this change could also work in favour of both private and state-owned fossil fuel entities that are hampering the energy transition.

Willaims argues that these “niche cases should not justify confidentiality across the board”. He elaborates: “Carbon markets and credits don’t have the best reputation, given what we’ve seen over the last decade or so of their use… More transparency, not more secrecy, would benefit everybody, I think.”

Leeds also observed these amendments, but his concerns are perhaps more subdued. He tells edie: “I’m probably over-optimistic but I believe we’ll start to see a market developing that comes down to trust and high integrity. Then, we will start to see differentiations in price – people will pay up for credits from countries where the system is robust and there is transparency.

“I wouldn’t be surprised if those working on credit ratings start to come up with country ratings for credits, pointing out which have the right infrastructure and are worth investing in.”

In short, nations refusing to be open about the credibility of their credits may have nowhere to sell them to – or, at least, be missing a significant economic opportunity by failing to create credits that trade at higher prices.

Private sector involvement

As for article 6.4, the process of designing and launching these markets has been marred by even more delays than 6.2.  Leeds said he saw the “can, certainly, being kicked down the road” at COP26 in Glasgow, and then again in Sharm-El-Sheikh.

With so much still to be decided, it is unlikely that governments will be able to generate credits to sell to businesses for at least another few years. Leeds observes that some of the detailed rules of 6.4 are “unlikely to get agreed upon until 2024, meaning we’re unlikely to get anything in place until 2025”. Technically, there’s no hard deadline by which nations absolutely have to sign off on this topic.

There may be a silver lining here: there is the argument that rushing talks and reaching week compromises will lead to weak and ambiguous rules.

Williams has already observed one key area of progress here. Emissions reductions verified under 6.4 can be “authorised” – safeguarded against double-counting by both the country and the business – or “unauthorised”. “The language in the text suggests, quite strongly, that companies should not use these unauthorized emissions reductions towards their net-zero targets,” Williams explains.

“They could buy them to support additional climate action,” he adds, but argues that the space for using them in accounting towards net-zero targets is “narrowing”. COP27 notably saw a UN-convened group launching a major new set of recommendations to ensure that net-zero corporate claims and targets are credible.

Nonetheless, we all know that climate mitigation and adaptation are not currently being scaled at the pace science tells us is required. And a delay to 6.4 is a delay in unlocking new sources of funding for emissions reductions and removals.

Leeds has observed that several governments are already making bilateral deals for carbon trading involving their private sectors as we await the final sign-off on 6.4 rules. These include Switzerland-Ghana and Papua New Guinea-Japan. Japan also has an internal ‘GX League’, enabling corporates in certain sectors to trade emissions reductions with each other. It also enables the use of internationally traded credits certified by the government of origin. The GX League launched on a voluntary basis in early 2022 but high levels of uptake indicate that most firms are preparing for a more mandatory setup.

This sort of approach may well emerge elsewhere. China has signalled a willingness to explore this approach, with its history as host of the world’s largest emissions trading scheme (ETS) positioning it well to do so. Also, at COP27, the Africa Carbon Markets Initiative was launched, targeting 300 million high-quality credits annually by 2030, predominantly from the energy transition. Then, in a more controversial move, the US’s climate envoy John Kerry announced plans for a new Energy Transition Accelerator (ETA), to finance the energy transition in developing nations in exchange for carbon credits.

With all these moves in mind, Leeds has observed that 6.4 may fast be becoming “irrelevant” for some nations. “Suddenly, you’ve got this growing demand for so-called voluntary credits sitting within mandatory markets,” he says.  Standard Chartered is supporting the Africa Carbon Markets Initiative and has also stated, in principle, its support of the ETA, while acknowledging that it is in the very early stages.

This is before one even considers the boom in truly voluntary carbon markets. These markets collectively surpassed $1bn in value in 2021. Mark Carney’s Taskforce on Scaling Voluntary Carbon Markets is predicting that their scale in 2050 may be up to 160 times larger than in 2020. The fact that net-zero targets now cover 91% of GDP is a strong indication that further exponential demand growth is on the horizon.

As the growth accelerates, so must efforts to ensure credibility and weed out the ‘junk’ credits. Both Leeds and Williams agree that a strong signal from the UN could set the bar for de-junking voluntary markets as well as the 6.2 and 6.4. Williams says: “The risk of Article 6 being set up badly is that these other markets look at Article 6 and say: ‘these are the UN rules, this is best practice’.”

The UN can also further guide which credit purchases corporates and nations can use in accounting towards goals, and which should just count as additional funding towards climate solutions. Additionally, the UN discussions are ongoing about the language on the human rights impacts of carbon markets, notably the land rights of Indigenous communities.

The UN has, for the first time, added an additional international climate meeting to the calendar for 2023, with a focus on increasing ambition from nations and moving from talk to action. So, the state of play may be very different this time next year. Or, once again, the carbon credit can could yet be kicked down the road.