Episode 7: There's a New Global Carbon Trading System—Article 6. Is It What We Need? [Full Transcript]
COP26 Part I
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Casey: Welcome to season 2 of Pricing Nature, where we believe that if we’re going to reverse climate change, market-based climate policy will probably play an important role. And we’re more likely to create good policy, and stick with it, if we all understand more about how these policies work and what they do. I’m your host, Casey Pickett.
These days, I’m trying to eat healthier. Less sugar, less meat, more vegetables. And in my family, we like incentives to help form good habits. So we designed a system -- for every serving of vegetables I eat, and every cookie I don’t eat, my kids reward me with artwork.
With vegetables, the system is easy. My kids tally up the servings, and return with drawings of vegetable-themed superheroes and cat-ninjas. But with the cookies, things get a little more complicated. Remember, they’re paying me for every cookie I don’t eat.
The other day, my older son literally caught me with my hand in the cookie jar, and I fessed up that I had eaten three cookies that day. “But,” I said, “On a normal day, I would have eaten five cookies! So I’m still ahead for not eating two cookies.”
Now, as you can imagine, he cocked his head and looked at me, incredulous. But he loves to paint, so I got a watercolor of the Mandalorian.
Now, I’m sure you’re saying to yourself … Seems a little problematic. Is that really fair? Who’s to say how many cookies you would have eaten on a normal day? It’s the right question to ask. …And it’s a question that has bugged global climate policy makers for years. They’ve been working on a similar system -- a global trading system -- designed to drive emissions reductions, instead of cookie reductions. And if it works well, some estimates say, it could cut the cost of global emissions reductions in half. But in order to do that, we have to avoid all the pitfalls that come with measuring the “cookies we don’t eat.” Or in this case, the greenhouse gasses we don’t emit.
Countries have been fighting over the rules of this global trading system for years. Finally, at the 26th Annual Conference of the Parties, COP26, we settled the rules. Today, we’ll learn the theory behind this global trading system, we’ll find out how geopolitical drama dragged out negotiations for six years, and ultimately, we’ll hear about what’s being done to make sure this new climate action tool doesn’t completely backfire.
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Casey: Welcome to Pricing Nature, a podcast from the Yale Center for Business and the Environment, the Yale Carbon Charge, the Yale Tobin Center for Economic Policy, and the Carbon Pricing Leadership Coalition. I’m Casey Pickett, Planetary Solutions Project Director and Director of the Carbon Charge at Yale .
Jacob: I’m Jacob Miller, a recent graduate of Yale College. Back in 2016, I was the first intern with the Yale Carbon Charge.
Cami: And I’m Cami Ramey, a graduate student at the Yale School of the Environment and the newest member of the Pricing Nature team
Casey: In this first part of the two-part episode you’re listening to now, we explain one of the key achievements at this year’s Conference of the Parties, COP26: A new global market to drive climate action. In part two, we’ll zoom out to understand why the COP process is simultaneously maddening and necessary.
Cami: If you’re trying to describe an apple tree, it helps to start with the apple.
Jacob: Today’s apple is the trading system established by Article 6 of the Paris Agreement. The system is… unique. It’s not quite a cap-and-trade system, and it’s not quite a carbon offset market either. And it’s definitely not a carbon tax.
Casey: And it’s also not a duck billed platypus, nor a tufted titmouse. Let’s talk about what it is.
ACT I: Article 6 - The Global Effort to Trade Climate Action
*music*
Casey: In 2015, 196 countries signed the Paris Agreement, an international treaty on climate change that set out to limit global temperature rise to 1.5 degrees Celsius. It was a huge breakthrough in global climate negotiations, made possible by a shift in policy design from top-down emissions regulation to a bottom-up approach in which Countries agreed to submit voluntary greenhouse gas reduction pledges, with the goal of winding down global emissions as quickly as possible.
And deep within the agreement, under the heading “Article 6,” countries created a trading system, designed to reduce emissions at lower cost. Let’s dive into the theory of this Article 6 trading system Cami -- I keep calling it a trading system, but what exactly are we trading? Carbon themed pokemon cards? Climate-art NFTs?
Cami: Well Casey, we’re trading something called Internationally Transferred Mitigation Outcomes. Also known as I.T.M.O.s, also known as “itmos” to folks who are especially crunched for time.
Casey: Internationally Transferred Mitigation Outcomes… that sounds every bit as jargony as I’d expect from the Conference of the Parties to the United Nations Framework Convention on Climate Change. ITMOs. I have a feeling we’re going to use this concept a lot, so… I’m gonna ask again: what exactly are we trading?
Cami: ITMOs dude! *jokingly* Get with it! *explanatory*
Casey: Oh sorry right, ITMOs, ya! *A la Dr. Evil* I’m hip! I can boogie! I dig it! Tukatukatukatuka
Cami: That was like the worst of the dad jokes you’ve ever pulled out. Ever.
Casey: Oh good, I’m always trying to break new ground, so thank you!
Cami: No, keep it in the ground! With the dinosaurs and fossil fuels… Keep it in the ground!
*music*
An Internationally Transferred Mitigation Outcome refers to all the kinds of climate action a country can put in its Nationally Determined Contribution -- or NDC pledge.
Casey: Remember, Nationally Determined Contributions are the core of the Paris Agreement’s bottom-up approach. At Paris, signatory countries committed to decide themselves (nationally determine) the contributions they would make toward the global goal of limiting warming to 1.5 degrees C. Then we add up all those contributions to see how we’re doing in relation to that goal.
Cami: In an NDC pledge, a country might commit to, say, cutting its emissions in half by 2040. Or a country might pledge to build more renewable energy power plants. Or it might promise to preserve 1 million hectares of forest. An Internationally Transferred Mitigation Outcome, or ITMO, can describe any of these kinds of climate action.
Casey: Alright, and we can trade ITMOs, this stand-in for all kinds of climate action. But what does it mean to trade climate action?
Cami: Basically, the Article 6 trading system lets one country buy credit for the climate action that happened in another country. Gilles Dufrasne (Zjeel Doo-frayne), a policy officer at CarbonMarketWatch, has been tracking Article 6 negotiations carefully. He helped us understand how this works:
Gilles Dufrasne: “I'm Gilles, I'm a policy officer at CarbonMarketWatch. We’re an NGO specialized in carbon markets and carbon pricing policies. I've been following international carbon markets for about four years now.”
Cami: We’ll hear from Gilles Dufrasne a lot today. He walked us through an example where one country buys emissions reductions from another country:
Gilles Dufrasne: [3:13] “For example, you could have, let's say Peru, that has reduced 10 tons of CO2 in a given year and the Swiss government that wants to count those tons and they go to the Peruvian government and they say, ‘Would you agree not to count those reductions towards your own target, and let us count them towards our target? And we'll give you money for that.’ ”
Casey: So Peru benefits from the foreign investment. And Switzerland benefits by getting emissions reductions at a lower cost than they would’ve at home, because it’s cheaper to reduce emissions in Peru than Switzerland. The theory is similar to any carbon trading system, really. We’re channeling money to the lowest-hanging fruit.
Cami: Right. And most of the time, Article 6 trading refers to emissions reduction trading. But remember that a country could also trade, for example, the amount of renewable energy power it built.
Casey: Okay, so putting that in terms of Gilles Dufrasne’s example: If the Swiss government pledged in their Nationally Determined Contribution, or NDC, to build a bunch of solar power, and Peru is building a bunch of solar power, the Swiss could buy credit for some of that power?
Cami: Exactly. And that credit is an Internationally Transferred Mitigation Outcome. ITMO!
Casey: ITMO! Got it. ITMOs is a tricky term though… let’s return to my healthy eating analogy to keep it in our heads.
Cami: Analogize away, Casey!
Casey: Why thank you, I shall. Despite the goofy name, ITMOs represent the most wonderful things—units of solutions to climate change. How sweet! So let’s think of them as… food—We need them to survive, and there are different kinds. Some ITMOs, like healthy foods, we want more of.
Cami: Like renewable energy generation, or forests. Those can be our vegetable ITMOs.
Casey: Perfect. We should want more of those; they’re good for us. And then there’s the stuff that’s bad for us, like cookies (sorry mom) that we should eat less of to be healthier. In climate-terms, these are greenhouse gas emissions—emissions reductions are like cookies we don’t eat. And here’s where things get weird. Remember my cookie jar?
Cami: Yes of course, you literally got caught with your hand in the cookie jar.
Casey: Yes! And once I actually got my hand caught in a cookie jar. But that’s another story. In this one, my oldest son caught me eating three cookies, but I said: “on a normal day I swear I would have eaten five so I actually avoided eating two cookies. So really, you still owe me artwork, kid.”
Cami: Yep. And this raised the question of, well, how do we determine how many cookies you’d eat on a normal day? Still seems a little problematic to me.
Casey: Nothing years of international multiparty negotiations couldn’t sort out!
Cami: I hope so…
*music*
Cami: So, what I hope we’ve made clear is that it’s easier to measure the cookies you do eat, than those you don’t.
Casey: Who’s to say how many cookies I would have eaten on a normal day, right?
Cami: Exactly, and this is where trading ITMOs gets tricky. While ITMOs can represent all forms of climate action, countries will mostly trade their reduced emissions, or uneaten cookies.
Casey: And like cookies, it’s easier to measure the emissions you’ve emitted than the emissions you’ve reduced. To figure out how much you’ve emitted, you put a meter on a smokestack, or you measure how much fuel you’ve burned.
Cami: But it’s harder to measure the emissions you’ve reduced, or cookies you didn’t eat. That’s because you need to figure out how much would have been emitted if you hadn’t done the thing that reduced your emissions.
Casey: You have to figure out how many cookies you would have eaten under normal circumstances.
There’s a handy economics term to describe this idea. Today’s episode is brought to you by the number six and the word “Counterfactual.” *riffs on the word-feel of counterfactual*
Cami: A counterfactual scenario is what would have happened if not for some intervention. In the case of emissions reductions, a counterfactual scenario is the business as usual case, where we didn’t upgrade to energy efficient technology, or replace a coal power plant with a solar plant, or change how we manage a forest.
Casey: Under Article 6, you can get credit for the difference between the counterfactual scenario, and reality. –The gap between what happened and what would have happened if somebody didn’t make a change.
Cami: Right -- and that gap is bought or sold as an emissions reduction ITMO. Here’s the problem: counterfactual scenarios are difficult to calculate, so that can lead to over-crediting—ITMO buyers getting credit for reductions that didn’t happen.
Casey: Hm, that does seem like a problem. If the system ends up giving credit for reduction that didn’t happen, it could become an ineffective tool for climate action, to say the least. What about the opposite problem? Do we need to worry about UNDER-crediting?
Cami: We generally don’t need to worry about under-crediting, because the benefits are directed to the environment -- it’s a positive externality. So we’ll focus on over-crediting, which could create problems. Gilles Dufrasne from Carbon Market Watch explained how over-crediting might work for a wind or solar power project if the counterfactual is inaccurate:
Gilles: “...let’s say… you were saying, without my windmills and my solar panels, everything would be generated by coal power. Then you're going to have massive reductions because it looks like you're really going from high emitting power generation sources to basically zero carbon sources. But maybe that's not what would have happened without the project. Maybe what would have happened would have been gas or even renewable electricity...”.
Cami: Depending on how you do the calculation, your emissions reductions could vary widely. That means, if measurements and counterfactuals are off, countries and companies who buy these credits might think they are offsetting their emissions a lot more than they actually are:
Gilles: “As soon as your credits start not representing the full ton of CO2 that they're supposed to represent, then you're actually emitting a lot more than you think you are, because you think you're compensating your emissions, but actually the credits don't represent impacts that they're supposed to represent. And so, your emissions are real, but the reductions are not. And so that's a big, big problem.”
Cami: [slow and measured (repeating Gilles)] Your emissions are real, but the reductions are not. In theory, one ton of emissions reduction can offset one ton of emitted CO2. But if there’s a mismatch, we’re in trouble.
Casey: We have to use the article 6 tool carefully. If we're not making real reductions, but counting reduction credits towards progress, we could be worse off than if we didn’t have a trading scheme at all.
*music*
Casey: Okay Cami, so far, we’ve defined ITMOs, the units of climate action that countries can buy and sell in the new trading system in the Paris Agreement. We’ve heard that most ITMOs are going to be emissions reductions. And we just learned that emissions reductions are really hard to measure, which could cause big problems for the new system. That leads me to my next question: if it’s so hard to measure emissions reductions, why is that what we’re trading? Why don’t we just do something like a cap-and-trade system, where we issue permits to emit CO2 and let countries trade those instead? Wouldn’t that be a lot easier?
Cami: That’s a great question Casey. You’re right, in theory, it would be much easier to measure all the CO2 emissions from each country, and then make sure they have permits for each ton of CO2 they emit. But Gilles Dufrasne explained why we couldn’t do that for the Article 6 trading system:
Gilles Dufrasne: “...cap and trade, as the name suggests, has a cap. So you're fixing the total amount of emissions that can be emitted by some entities, whether it's companies or individuals or countries or whatever… Whereas under Article 6, you don't have a cap.”
Cami: In a cap-and-trade system, someone controls the number of permits in the market -- that’s the cap. But in this case, who would decide how many permits to issue?
Casey: Couldn’t the countries just negotiate and decide together, like they do for the other parts of the agreement?
Cami: Well they tried that once… The result was the Kyoto Protocol. It turned out to be too hard to satisfy everyone, so the US walked away from the agreement. The world moved forward with the Kyoto Protocol, but it had much less influence than it might have had with the US involved. That’s why we moved to this system of voluntary contributions.
Casey: Alright, so we need a system that gets countries to reduce their emissions, but without an international binding cap. Something voluntary. Countries have already pledged to voluntarily reduce their emissions. So to get countries to reduce their emissions even faster, we created an international market, where countries can sell their reductions.
Cami: Ya, you’ve got it.
Casey: Okay. Next question: I get why a country might want to sell its emission reductions in this system. Maybe it reduced more than it expected to, or needs foreign investment for a project that will reduce emissions… But without an international cap on emissions, why would anyone buy an emissions reduction? You could always just emit as much as you want, without any risk of a penalty, unfortunately.
Cami: Well, to answer that question, let me introduce our next guest, Rishikesh Ram Bhandary, Rishi for short. He’s the assistant director for the Global Economic Governance Initiative at Boston University’s Global Development Policy Center. Rishi Bhandary explained that the Paris Agreement lets countries do what they want, in the hopes that they’ll feel intrinsically motivated to hit their targets.
Rishi: “The Paris agreement was not designed to be a compliance heavy international agreement…. It does not have, by design, the kinds of legal teeth that some other legal agreements would have… The idea was that countries will deliver on what they have committed to because they chose what to commit to.”
Cami: The logic is: what’s the point of setting a target you know you won’t hit? And if you want to hit your target, but aren’t on track to, you can buy an ITMO.
Casey: Hmm… It’s like my running metaphor from last season… If I’m going to run a 5k and I want to set a personal best, I’m not gonna say ohh ya I guess I’ll run my next 5k in under 15 minutes. That would be crazy -- there’s no chance I’ll hit that time. But I might set a goal of running it in under 18 min, because with a little (honestly a lot) of training I might be able to hit that. I want to pick a target that motivates me to improve.
Cami: Casual flex, Casey! 18 minutes?!
Casey: What? Who, me? I’m just over here, stretching.
Cami: Okay, okay. So you’ve described an optimistic view: Nationally Determined Contributions are self-determined, so it’s reasonable to assume that countries will do their best to hit them. That’s one reason why a country might buy emissions reductions -- if it’s struggling to hit its target, but really wants to, it can purchase ITMOs to get across the finish line.
Casey: And isn’t it possible that a country would set its target with these credits in mind? Some countries might have planned to buy cheaper emissions reductions than they can achieve at home.
Cami: Definitely. But there’s another side to this. You asked, without a cap, why would a country buy emissions reduction credits? And the truth is, some countries might not be interested in buying these credits at all.
Casey: Oh? Why?
Cami: They might be focused on reducing local air pollution, and improving public goods like transit and energy systems -- you only get those benefits with local emission reductions.
Casey: So a country that wants to focus on local climate action might not buy emissions reduction credits. But what if that country isn’t on track to hit its emissions target?
Cami: Well, without a cap, there’s no reason a country would have to buy emissions reductions to hit its target. Countries may just… miss their targets,
Casey: La la la la la, no, I don’t want to hear that! We can’t have countries missing their targets.
Cami: I know, but for a variety of reasons, it may happen.
Casey: Uh I refer you to section A in which I said “La la la la la, no, I don’t want to hear that!” Okay, but I’ll humor you. Reasons like?
Cami: Well, an economic recession might make it unexpectedly hard to hit the target. Or a shift in political administration could lead to a drastically different approach to climate action, like we saw in the U.S.
Casey: Got it -- and I suppose some leaders might pledge one thing to a global audience, but then political pressures at home could lead them in another direction.
Cami: Or they might make an ambitious pledge, in the hopes that other countries will do the same and end up carrying their weight for them–freeriding.
Casey: Or a target could be aspirational… in the words of Daniel Burnham: “Make no little plans. They have no power to stir men’s blood.” You set a big target in the hope that it stirs people to innovate and act.
Cami: Exactly. There are all sorts of competing factors that might lead a country to set a target it ends up missing. Without a cap, the pressure to achieve your emissions goal only comes from international, social pressure.
Casey: Which only sometimes works…
*music*
Casey: Alright so what have we learned so far about the challenges of the Article 6 market? Trading emissions reductions is weird because A) Just as with cookies you don’t eat, it’s hard to calculate emissions reductions —the issue is: compared to what?! And B) there’s no cap on global emissions, so countries might not be motivated to actually buy emissions reductions credits.
Cami: Yeah, all in all, the Article 6 trading mechanism is pretty finicky -- and that’s just the theory behind it. When we tried to put this plan in motion with detailed rules, politics made things even messier.
Casey: How so?
Cami: I’ll pass it over to Jacob to explain.
Jacob: Thanks Cami -- let’s head over to Act II to find out how politics got in the way of the Article 6 rollout. Spoiler: it took six years to finalize the rules, and not everyone is happy with how things turned out.
*music*
ACT II: Article 6 Gets Political
Jacob: Gilles Dufrasne gave us a few reasons to approach Article 6 with a healthy dose of skepticism… There’s no cap on global emissions, and it’s challenging to trade emissions reductions, because they’re so hard to measure. Gilles Dufrasne is not the only person that’s been concerned about getting this trading system right. Negotiators from every country were locked in discussions for six years, fighting over the technical details of Article 6. Some countries wanted to establish a stringent set of rules with strict environmental integrity. Others were trying to win an advantage in the new marketplace. But finally, at COP26, negotiators came to an agreement that would set Article 6 trading in motion.
Casey: So, Jacob, can we dig into the details of the rules a bit?
Jacob: Oh ya, brass tacks nuts and bolts are ready to make a comeback. Time to get into the weeds.
Cami: You might even say we’re getting into the nitty gritty details!
*Jacob and Casey doth protest too much*
Jacob: Oh Cami, we don’t say that anymore!
Cami: What’s happening. Why.
Jacob: It’s a season 1 thing.
Cami: I see, a “season 1” thing…
Jacob: The story is, we said that about 6000 times in season 1 and we decided… no more. No nit. No grit.
Casey: No way you could have known, don’t worry about it.
Jacob: This is “Pricing Nature BC”: Before Cami.
Cami: Haha I love that…
Casey: This is as rough as we get to new members on this show.
Cami: Okay, well, I think I need to go back and listen to some of these episodes, to understand why you guys are coming for me right now…
Jacob: Sounds like a plan Cami.
Casey: Alright. We are sorry to see you go, but we will see you back here at the end of the episode!
Jacob: Peace Cami.
Cami: See ya later alligators.
Casey: Later skaters.
*music*
Jacob: Anyways, let’s get back to those pesky rules! Article 6 is absolutely full of rules. And we’ll focus on just two issues that got a lot of airtime in the debate: double counting emissions reductions, and the use of Clean Development Mechanism credits from the Kyoto Protocol.
Casey: Alright well, let’s start with the first one. Tell us about double counting first.
Jacob: Alright, so here’s the problem: when one country trades an emissions reduction to another country, who gets to count that reduction? Gilles Dufrasne walked us through a hypothetical problem scenario...
Gilles: “ So if Switzerland is buying a reduction from Peru, then how can you be sure that you're not going to end up in a situation where Peru says, well, I have reduced a ton of CO2, so I've met my target. And then Switzerland is going to say, I have paid them to reduce a ton of CO2. So I have also met my target.”
Casey: Now, this seems like an open-shut case to me. Shouldn’t Switzerland get credit for the reduction? Otherwise, what’s the point of buying the reduction? They’re buying the ability to claim credit for the reduction.
Jacob: Well Casey, Gilles Dufrasne agrees.
Gilles: “The same thing with any other good, if I build a table and I sell it to somebody else, then somebody else has a table and I don't have it anymore. It's the same thing with emission reductions. If I achieve an emission reduction and somebody else buys it from me, then they can count it. And I can't.”
Jacob: It’s just math, right? 1+0 should not equal 2.
Casey: Ya, pretty tough to find any way around that. And yet, we’ve been debating the issue for five years so… who is pro double counting?!
Gilles: “So that one is relatively clear and it's basically one country, which is promoting double counting, which is Brazil. And they’re quite isolated on this”
Casey: Wow, just threw ‘em right under the bus.
Jacob: Oh yeah, Gilles does not hold back. Rishi Bhandary provided context as to why Brazil would want to allow double counting. Rishi gave one interpretation related to old NDC pledges…
Rishi: “They've already put in place climate policies, right? The initial round of pledges under the Paris agreement are already there…. If you open up your domestic market for investments into carbon credit projects from all around the world, the fear is that most of the money is going to go to the lowest hanging fruit. And therefore, if the government now can no longer rely on those very projects to meet its own targets, and instead if some other country or some other set of investors are using those cheaper projects for their own goals, the government is stuck with a more expensive set of projects.”
Casey: So Brazilian leaders might look at its NDC now and say, ‘sheesh, hitting our goals could be a lot pricier than anticipated… we’re not allowed to count the credits we intended to sell.’ And they won’t just submit a new, weaker NDC, because the expectation is that each NDC should be more ambitious than the last.
Jacob: Right.
Casey: That seems to imply either a major failure to understand what Article 6 would mean before countries submitted their NDC pledges, or a refusal to take seriously the market Article 6 would create.
Jacob: Ya, and I should note that the whole “we didn’t see this coming” interpretation is pretty generous to Brazil. But Rishi is a generous guy -- he sat for three interviews with us.
Casey: Rishiii. Is there a less generous interpretation?
Jacob: A less generous interpretation would say that Brazil wanted to “have its cake and eat it too.” They wanted to sell the reductions from their low-cost projects, and also get to count those reductions from those projects. Brazil will be the site for a lot of emissions reduction projects, so double counting would really help them achieve their NDC goals.
Casey: Well, the rules are locked in now, so what’s the verdict? Is Brazil going to…have its cake and eat it too? Or have its cake and sell it too? Is there a more apt metaphor we can use here? You can’t build a treehouse in the tree from which the boards are made?
[banter]
Casey: So… what’s the verdict?
Jacob: Well this year, Brazilian negotiators embraced an accounting rule known as “corresponding adjustments,” which allows only one country to receive credit for an emissions reduction.
Casey: Hm, toss “corresponding adjustments” in the jargon bucket with ITMOs… How do corresponding adjustments work?
Jacob: It’s basically an accounting rule that says, if you sold an ITMO, you can’t count that emissions reduction towards your own target.
Casey: Hm, seems like a big phrase for a simple idea. If you sell it, you have to adjust your accounting to show you don’t have it anymore. But in any case, that sounds great! No double counting! That’s a step in the direction of a stringent trading system. But why did Brazil change its tune all of a sudden?
Jacob: Well, some experts point to a joint statement released by Brazilian business leaders, just a few weeks before COP26. These business leaders urged the Brazilian government to rethink its stance on double counting, saying Brazil could be quote: “excluded from a new economic-climate order that is unfolding before our eyes.”
Casey: Interesting… so Brazilian business leaders see Article 6 trading as an opportunity for increased foreign investment, not a regulatory squeeze. And they wanted to get the market rules in place as soon as possible?
Jacob: Exactly.
Casey: Alright, so that’s double counting. The international community wasn’t having it, and finally, Brazilian businesses lobbied their government to stop advocating for double counting… Success! Now, you mentioned a second focus of Article 6 negotiations?
Jacob: Yes -- this second issue is a little trickier. It has to do with how the Article 6 markets will deal with old credits from a predecessor to Article 6. These old credits are known by a few names, but we’ll call them Clean Development Mechanism credits, or CDM credits. You may remember hearing about these back in season 1.
Casey: Yes, but can you remind us what a CDM credit is?
Jacob: Absolutely. To understand CDM credits, we need to review a little history again. In 1997, way back at COP3, countries signed the Kyoto Protocol, which established a global greenhouse gas cap-and-trade system. The Kyoto Protocol set targets for the richest countries, and, importantly, the negotiators did not set targets for low- and middle-income countries.
Casey: That ended up being the downfall of the Kyoto Protocol, right? The U.S. wouldn’t sign on if low and middle income countries, particularly China, didn’t have targets.
Jacob: That’s right. Instead of targets, there was the Clean Development Mechanism. Under the Kyoto Protocol, the Clean Development Mechanism enabled low and middle income countries that reduced their emissions voluntarily to sell credits for those reductions. Rich countries could buy CDM credits and count the reductions towards their GHG reduction targets.
Casey: Gotcha -- so the Kyoto Protocol basically set up a carbon offset market. Country A could invest in an emissions reduction in Country B, and then Country A would count the emissions reduction for itself.
Jacob: Exactly. Now here’s the problem… the Kyoto Protocol expired in 2020, before many of the Clean Development Mechanism credits were sold. There’s a big pile of leftover CDM credits. And some countries want to sell those credits in the new Article 6 market.
Casey: So the question is -- should countries be allowed to buy and sell old CDM credits?
Jacob: Yes. And this is a problem, because many people are suspicious of the quality of CDM credits.
Casey: How so?
Jacob: Gilles Dufrasne explained why the Clean Development Mechanism has such a bad reputation:
Gilles: “..if you want to plant trees or build solar panels or whatever, you can't just go in your backyard and install some solar panels and then make a back of the envelope calculation and say, I have reduced a hundred tons of CO2. You need to follow these very detailed rules. And these are a big part of what was problematic under the CDM... they left some loopholes, they left some doors open for project developers to really pick and choose the rules that they liked, and that would maximize their impact…
Jacob: It goes back to our conversation about counterfactual scenarios. The CDM wasn’t very good about figuring out how many cookies you would have eaten on a normal day, or emissions you would have emitted under normal circumstances.
Casey: So there’s a risk that the new market will be weaker if countries start buying and selling these questionable credits?
Jacob: Exactly. And it’s not just that the credits are low quality. Some of them are also quite old! Gilles Dufrasne says that, even if the credits were high quality, too much time has passed since they were created for them to have a meaningful impact on the climate. He gave the example of a windmill project built in 2010:
Gilles: “So you have installed a lot of windmills in 2010, and then the project developers who have done that have said, well, we have reduced emissions because we have generated electricity. And so this replaces the electricity from coal. And so we get credits for… building all these windmills, and then nobody ends up buying those credits... And you wait five years, 10 years, 15 years. And still the credits are still there on the market. Nobody has bought them.
And so you now have the question, is it okay for the US, for anyone else, for a company even, to buy those credits and say, this is a legitimate emission reduction, it's an impact we have achieved, when actually this reduction was achieved a long time ago. And really, buying the credit today makes zero difference to the atmosphere.”
Casey: It’s like if I ate some vegetables, or didn’t eat some cookies, ten years ago, and then I wrote it down, and now in my family’s healthy eating scheme, tried to cash in those points for artwork. My kids would be like, ‘Wait, I wasn’t even alive when you didn’t eat those cookies. That act is not making you healthy NOW.’
Jacob: Exactly.
Casey: If we wait 10 or 15 years to buy the credit, our accounting gets all messed up. On one side of the ledger, we have current atmospheric CO2 measurements, and on the other side, we would have 10-15-year-old emissions reductions. We might think we’re reducing emissions today, when in fact the reduction happened over a decade ago. But what about a five-year-old credit? At what point does a credit stop being relevant to the atmosphere?
Jacob: Well, that’s a good question, Casey, and it takes us into another layer of this debate, and that’s the issue of investor confidence… the idea that investors are more likely to invest in new projects if they think they’ll be able to sell all the credits generated by those projects. There’s a case to be made that the longer credits can be sold on the market, the more confidence investors will have, and the more projects they’ll invest in.
Casey: More money flowing to climate action would be great for the climate.
Jacob: Yes, but the older a credit is, the more it screws up our accounting. The way Gilles Dufrasne sees it, if an investor fails to sell credits from their project in a short time frame, then tough luck:
Gilles: “I don't think there was a legitimate expectation from project developers to really sell after the end of the Kyoto protocol. So a developer that built solar panels or developed a windmill project in 2009 or 2010, I don't think they did that in the hope of selling credits in 2025, rather, they were hoping to sell credits immediately in 2012, 13, 14. And it didn't really happen. The market collapsed, but that's also the nature of the market. There was never a promise to buy carbon credits. There was a promise to establish a system, where project developers can sell these credits.”
Jacob: Gilles Dufrasne feels that project developers were taking on some risk when they invested in their projects, and that’s just the way of the market. And he also disagrees with the investor confidence argument more fundamentally:
Gilles: “Carrying over all those credits would actually be a lose-lose situation. It would be bad for the climate because we're just carrying old reductions that don't make a difference today. But it will also be bad for project developers because there's a huge amount of credits that could potentially be eligible. And so the prices which are today incredibly low, below $1 per ton, are going to stay very low…”
Jacob: Gilles thinks the argument to carry over CDM credits into the new system is coming from legacy developers, who are just trying to recoup their old investments. But he says carrying over old credits would probably keep the price low and would make it harder for new developers to sell credits.
Gilles: “This is not benefiting anyone who wants to implement new projects. If you want to implement new projects, you have zero interest in having old projects and old credits still on the system. You basically want there to be no supplies so that you can sell your credits more easily.”
Casey: That’s a fascinating take on the investor confidence argument… Gilles Dufrasne is saying, by flooding the market with inexpensive, low-quality credits, you’re crowding out the new project developers. So for the confidence of new project developers, you should exclude old credits.
Jacob: Exactly.
Casey: Alright, now we’ve got a grasp of the debate… There are a large number of credits from the era of the Kyoto Protocol, these CDM credits. They may not represent the emissions reductions that they claim to, and they’re quite old. And negotiators need to decide whether or not to include CDM credits in the new market.
Jacob: It’s clear that what the negotiators decide about the CDM credits could affect confidence in the new market. But it’s not clear if the CDM credits will bring more or less confidence.
Casey: Alright, well… after 6 years of debate, where did we land? Can you walk us through the final decisions?
Jacob: Sure thing Casey. Let’s do Act III.
ACT III: The Art of Compromise
Jacob: The big Article 6 questions going into COP26 were, will there be this problem of double counting? And, what are we going to do about all these old CDM credits? We already heard what happened on double counting.
Casey: Right, the loudest proponent of double counting was Brazil, and after pushback from Brazilian business leaders, the Brazilian negotiators backed off the issue and embraced corresponding adjustments. That means the same GHG emission reduction will not be counted by two separate countries. And so, what about the CDM credits? That was a pretty big deal too…
Jacob: Well Casey, in the end, negotiators came to a compromise. Let’s just say… Gilles Dufrasne was not psyched.
Casey: Did he throw more people under the bus?
Jacob: No no… I’m sorry, do I make it sound like he’s not nice? He’s a very nice guy. He’s just got high standards.
Gilles: “The final agreement that was reached at the COP is really weak. That's probably an understatement; it's really far below where we would have liked to see. I think countries have compromised too much on this issue. The final deal basically says that you can use credits, as long as they come from projects that were registered after 2013, but that's close to 10 years ago, so that's still quite a long period.”
Jacob: Negotiators decided that CDM credits generated by projects from 2013 or later can be used in the Article 6 market. Gilles explained why he thinks negotiators came to this decision:
Gilles: “We're acting as part of a negotiation with 190 plus countries. And so you have to give and take. Of course, we're not going to end up with everything that the more ambitious countries want and nothing that the less ambitious countries… I think it’s very unfortunate, and at the same, that’s how negotiations happen.”
Jacob: This compromise wasn’t about ensuring the best outcome for the planet. It was about politics. Certain major players have a lot of leftover CDM credits to sell… countries like China, India, and Brazil. And they’re all facing a lot of pressure from investors in their countries, investors who put money on the line and have really strong views on this issue. So in order to appease these countries, negotiators included a portion of the CDM credits.
Casey: Okay so there’s a trade-off here… some really old credits are canceled. But some remain in play -- and it was a necessary compromise to get big players in the global economy to sign on to the agreement.
Jacob: Yes, and you’re right it’s definitely a trade-off. The inclusion of CDM credits will be a blow to the environmental integrity of Article 6. Gilles Dufrasne’s organization, Carbon Market Watch, estimates that around 300 million CDM credits are now eligible to be used under Article 6. That’s 300 million suspect credits of CO2, available for purchase. But without those credits, we may not have any finalized rules at all.
Casey: Jacob, can you put that number into context for us? How big a deal is 300 million tons of suspect carbon credits?
Jacob: Let’s compare it to the global carbon budget, that is, the amount of carbon we can emit before we’re guaranteed to hit 1.5 degrees Celsius of global warming. There are a variety of estimates for this global carbon budget, but it probably falls between 300 and 500 billion tonnes of carbon. So by order of magnitude, we’re talking about 1/1000th of the global carbon budget.
Casey: It’s not nothing, by any stretch… but it’s also not the whole ballgame.
*music*
Casey: Did we end up with the right decision here? Was it worth sacrificing some environmental integrity to finalize the rules?
Jacob: There are a few ways to answer that. One perspective comes from Bianca Gichangi, a coordinator for the Eastern Africa Alliance on Carbon Markets and Climate Finance. Her organization trained a lot of the East African government officials that negotiated the Article 6 issues. She feels that no matter the compromises that were made in the rulebook, it was more important to set the Article 6 rules than to make them perfect. She says that governments in Eastern Africa have invested a lot of time and resources into preparing for the Article 6 market, and there was a growing concern that Article 6 might stay in flux forever. These governments didn’t want to keep working on something that was destined to crumble.
Bianca: “...there was a real risk that, if we didn't get a decision this year, people would just move on, you know? And it's like, that's not what you want. You know? So I was really, really happy with the outcome.”
Jacob: We also spoke to Michai Robertson, an advisor with the Alliance of Small Island States, AOSIS. He helped provide legal support to AOSIS negotiators. Michai agreed that it was important to get moving on Article 6, because some countries were already starting to make trades…
Michai Robertson: [38:28] “…it was already happening. And they were happening without rules. So I think that's a good way to look at this entire problem. We didn't have this guidance to give to countries when they're implementing internationally transferred mitigation outcomes. Right? And so, the world is moving on without us.”
Casey: So with some countries already trading without rules, there’s a risk that they’d double count their emissions reductions. Or they’d trade really old credits that don’t represent real reductions.
Jacob: Exactly.
Michai: [40:23] “When we went into Glasgow, we were like, we're going to get this done. Because there are people that could potentially abuse the system without the rules…
And I think we got the best outcome that we could have gotten, noting all of the varying different interests and positions of countries around the table.”
Jacob: Remember the example Gilles Dufrasne gave about Switzerland and Peru? It’s real. In 2020, Switzerland and Peru signed an agreement for Switzerland to finance emissions reduction projects, like clean cookstoves, in Peru. In exchange, Switzerland will count those emissions reductions towards its own emissions target. Luckily, Switzerland and Peru had already taken some steps to avoid abusing the system… For example, their deal voluntarily avoids double counting those emissions reductions. But now that the rules are in place, all trades will have to maintain these high standards.
Casey: High standards? Ensuring at least some environmental benefit from each ITMO trade seems like a low bar for a high standard. But global climate negotiations are clearly a realm in which the perfect is often the enemy of the good. When we look at the six years it took to nail down Article 6 rules, or the 18 year gap between Kyoto and Paris, it seems fair to conclude that we should lock in progress when we can, and try to ratchet up the next chance we get.
*music*
Casey: So we’ve heard that there was a compromise on including CDM credits, but some negotiators think it’s worth the sacrifice to get Article 6 rules in place.
Now, the reason the CDM credits are so controversial is that the Clean Development Mechanism had a mediocre-to-poor reputation. Jacob, How do we ensure that the new system isn’t just a repeat of the Clean Development Mechanism?
Jacob: There are several ways the negotiators designed the Article 6 market to improve on the Clean Development Mechanism. For example, the negotiators set stricter rules for measuring counterfactual scenarios, to limit the risk that any project’s emissions impacts are overestimated.
Casey: So… project developers will have to prove that a new solar plant is actually displacing fossil fuel energy?
Jacob: Exactly. And there are more improvements over the Clean Development Mechanism.
Casey: OK, with the remainder of our time, could you cover maybe …three of Article 6’s improvements over the Clean Development Mechanism?
Jacob: Sure Casey. There’s a 2% credit cancellation rule; a new focus on human rights issues, and there’s a requirement new projects produce co-benefits alongside their climate action.
Casey: Sounds like a plan. Let’s hear it. First, I’m curious about this 2% credit cancellation requirement. How does that work?
Jacob: It’s basically a safety net to prevent over-crediting.
Whenever emissions reduction credits are traded, 2% of those credits will be canceled. That means if a project reduced 100 tons of CO2 emissions, you can only sell 98 tons worth of credits. The rest of the credits are just taken out of circulation.
Casey: It’s like an automatic deduction for a kind of insurance against faulty credits; to make sure we’re really bringing down global emissions.
Jacob: Gilles Dufrasne says this is a slight improvement on the old system:
Gilles: [3:35] “On the one hand that's really good, because it sends a signal that breaks from the past… At the same time, well, 2%, it's really small, so it's more of a symbolic element. But it definitely opens the door for more conversations on this and hopefully we can get a higher share in the future.”
Casey: So the 2% credit cancellation helps reduce the risk of over-crediting, and it’s laying the groundwork for the future. It’s symbolic of a desire to bend the emissions curve faster, and it provides one way to ratchet up ambition. We could start canceling more credits from each trade. How about the next improvement? More focus on human rights?
Jacob: Yeah, there were repeated instances of human rights violations linked to the creation of Clean Development Mechanism credits. Projects have displaced low-income and indigenous populations, or strained food and income security. We’ve linked to some case studies on our Substack page.
Casey: So Jacob, what do the Article 6 rules do to set up safeguards for human rights?
Jacob: I’ll let Gilles Dufrasne explain:
Gilles: “One of the asks that civil society pushed very hard for at COP 26 was to have better rules on local stakeholder consultations, and also to have a grievance mechanism established on the market. And that was one of the good outcomes of the Article 6 deal, that there was a grievance mechanism established and is managed by an independent body, which was also a strong ask, otherwise there was the risk of having the grievance mechanism managed by the body that took the initial decision.”
Casey: This sounds like a step in the right direction, Jacob.
Jacob: Agreed. We’ll just have to keep scrutinizing the system to make sure it doesn’t repeat the mistakes of the past.
Casey: And how about the third item: project co-benefits? So these are things like, with a clean cookstoves project, the new stoves produce less CO2 per meal cooked, and improve indoor air quality in homes, enabling people to live longer. Or, if you install community solar in a rural village, you can increase student access to light for doing homework, so you can improve educational attainment. Or a forest carbon project might create more habitat for wildlife.
Jacob: Exactly -- Bianca Gichangi, who we heard from earlier, noted that under Article 6, emissions reduction projects now need to result in some kind of co-benefit, like the ones you mentioned.
Bianca: [24:13] “It's very important for African countries really to see the benefits of some of these projects trickling down, because a lot of the criticisms that were received in the past are like, yeah, you're having this project, but how is it actually trickling down to the community? How useful is this really to the end user?
The host parties themselves are going to have a lot more responsibility in saying that if you want to do this type of project, you have to show what these benefits are going to be to the NDC first and foremost, and then second, in terms of sustainable development, what this is bringing in?”
*short music*
Casey: So we’ve got a 2% safety net, human rights protections, and co-benefit requirements. All these improvements over the Clean Development Mechanism give me hope. We have to keep Gilles Dufrayne’s skepticism in mind, but we also need to keep moving ahead, locking in the progress we can, as we go.
Jacob: Yeah, I agree, and I should also add, even the biggest concern we looked at, that we now have 300 million old credits on the market, even that concern might be smaller than we thought. Bianca Gichangi says, there’s reason to hope not all of them will get used.
Casey: How’s that?
Jacob: She says that the private sector is more and more concerned with the quality of the credits they’re buying, so there may not be much demand for old, questionable CDM credits:
Bianca: [57:39] “It’s so funny. When you speak to some, to some industry practitioners, they'll tell you how some private sector developers are telling you, I want units with a corresponding adjustment. And you're like, we haven't even decided on that yet! You know? So, it’s like, they want the premium, premium, quality, quality units.
…
That's where I think it becomes really important to be transparent. If you're going to buy all those CERs, like people should know you're buying those CERs.
Jacob: CERs is just the technical name for a CDM credit. CER is Certified Emissions Reduction.
Bianca: “…And then as an investor in that company, I should be like, why is my money going to old CERs?! You know, you need to be transparent -- if you're going to buy those old CERs, just be transparent about it so people can not invest in your company…
But you can never tell, because CERs are cheap. So there might be someone, somewhere, who just wants cheap CERs.
…but the general, cause I can't predict this thing, the general feel that I get is that quality is becoming important and we're seeing that even right now.”
Jacob: It’s not just companies that are avoiding low quality credits -- Costa Rica, Colombia, Switzerland, and Finland have already pledged to avoid using CDM credits entirely. They’re also committing to use more stringent rules than Article 6 has outlined.
Casey: That’s interesting, Jacob… sometimes COP feels like a race to the bottom, like what’s the least we can do to avoid climate catastrophe. When you need to get everyone on board, you end up catering to the lowest common denominator. But you’re saying some countries are racing to the very top of the mountain.
Jacob: Yeah, and I think it’s important to keep both of those ideas in mind. We saw countries fighting to include old emissions reduction credits with questionable integrity, but there are also countries and companies pledging to never use those same credits. And it turns out, what we saw today in Article 6 is actually just a microcosm of the larger COP process…
Cami: Next episode, we’ll travel to COP, where we’ll see more examples of this “race to the bottom, race to the top” phenomenon.
Casey: Cami’s back! Welcome back Cami!
*music*
Casey: Today, we unraveled some of the complexities of the Article 6 trading system…
Cami: We learned about the pros and cons of trading emissions reductions instead of pollution permits… Internationally Transferred Mitigation Outcomes, or ITMOs, enable us to trade without a global cap on emissions.
Jacob: We got our hands dirty in the debates around double counting and questionable Clean Development Mechanism credits… Negotiators decided to include some old credits in the new market, but we managed to avoid double counting.
Casey: And we asked, is it better to get the Article 6 rules perfectly right, or to set the market in motion? There’s no clear answer, and it’s why we need to keep paying attention to the Article 6 market. The stakes are high, so we’ve gotta get this thing right enough, without stalling too long.
Next time on Pricing Nature, we’ll travel to the 26th Annual Conference of the Parties, COP26. We saw a small sliver of COP26 today -- that sliver will help us better understand the complex geopolitical dynamics that make up a Conference of the Parties.
Cami: Remember, if you’re trying to describe an apple tree… it helps to start with an apple. In our next episode, we’ll try to understand the tree.
Jacob: Thanks for joining us for Pricing Nature. And don’t forget, if you like what you heard…
KIDZ: Rate and Review! Like and Subscribe! Follow! Kidz out.
Casey: This episode was written by Jacob Miller, with help from Casey Pickett, Cami Ramey, Naomi Shimberg, and Maria Jiang. Sound engineering by Jacob Miller. Original music by Katie Sawicki. Thank you to all of our guests, and to Maggie Ferrato, for their guidance through this weedy topic. You can find more about our guests’ work on our website, pricingnature.substack.com.
Special thanks to the Carbon Pricing Leadership Coalition, the Center for Business and the Environment, and the Tobin Center for Economic Policy for their partnership, and to Ryan McEvoy, Stuart DeCew, and Heather Fitzgerald for making this episode possible.