Listen: COP28 is a pivotal moment for carbon markets: can countries move forward on Article 6?

Hello and welcome to the Platts Future Energy Podcast from S&P Global Commodity Insights. Today our focus turns to the COP28 event in Dubai, UAE, and its implications for the future of carbon markets. Focusing on Article 6, which sets out the rules for global trade in greenhouse gas emissions and has a critical role to play in the development of carbon markets.

My name is Eklavya Gupte. I'm an editorial lead on the EMEA News team. I'm joined by Dana Agrotti, a low carbon analyst covering the voluntary carbon markets and Article 6. And I'm also here with Vandana Sebastian, a senior pricing specialist in our voluntary carbon markets team. Welcome. In a few weeks, global leaders, scientists, policy makers, activists, journalists, delegates from every industry and almost every corner in the world will gather in Dubai For the 28th United Nations Climate Change Conference taking place from November 30th to December 12th. World leaders are under significant pressure to accelerate their climate action plans and take concrete steps to reduce global emissions. This comes at a time of significantly warmer temperatures with 2023 set to be the warmest year ever according to climate scientists. And global CO2 emissions are estimated to rise to record highs in 2023 with emissions from coal and oil, particularly continuing an upward trend.

There are a myriad of key priorities for the summit, one of which is the global stocktake, which itemizes what countries and stakeholders are doing or failing to do so to meet the Paris Agreement commitments. This is the centerpiece in global climate efforts and is designed to help chart the solution pathways to 2050 and help to set ambitious targets at a global and national level. Many countries are also hoping that COP28 will result in an ambitious but well-managed phase out of fossil fuels. But underlying all these issues is the operationalization of a global carbon market, which in a sense is at the heart of COP28. Article 6 of the Paris Agreement allows countries to voluntarily cooperate with each other to achieve emission reduction targets sets out in their nationally determined contributions. So first I would like to start off with a little bit of a definition on Article 6 and in particularly about Article 6.2 and 6.4 and how this is very central really to what will be going on in Dubai in a few weeks.

Thank you Eklavya for the question. So Article 6.2 basically refers to bilateral agreements between nations. These are country to country agreements that have certain common principles that allow countries to adopt to allow these cross-border exchanges of credits. So right now these credits called Internationally Transferred Mitigation Outcomes are already being actively traded across the globe. There are a number of countries, especially Japan and Singapore and Switzerland who are being very active, especially as bio countries. Then we have Article 6.4, which is the mechanism that is set to replace what is currently the Clean Development Mechanism. As of now, it's still unnamed. It will be overseen by the supervisory board that will actually approve projects under Article 6.4 after which credits will be generated and then they can be traded.

The idea is that there'll be a diverse range of methodologies, there'll be no set formula for establishing a baseline for carbon emissions and the new mechanism will examine individual party baseline estimates and then they will be adjusted according to their respective circumstances. What makes Article 6.4 tricky is the fact that you need approval. If you want to buy a project, for instance, the project must be approved both by the country where it is implemented, which would be the host country, as well as the supervisory body before these UN recognized credits can be issued. Now these credits can be bought by any party, they can be bought by a country, they can also be bought by a company, they can also be bought by individuals to offset their emissions.

It's also worth noting that Article 6 has provisions for a non-market mechanisms to ensure cooperation between different countries. This is under Article 6.8, which recognizes specifically non-market approaches. For instance, this could be learning by doing models or capacity building that different countries can design to cooperate on emission reductions through a non-market framework.

Thank you both. Now, honing in on Article 6.4, Dana, what is currently holding this mechanism back and why is it taking so long to agree on the guidelines and rules?

So as Vandana mentioned earlier, the Article 6.4 mechanism supports the development of an integrated global carbon mechanism overseen by a United Nations body, which would be the Article 6.4 Supervisory Body. So differently from Article 6.2, there are actually a number of issues which are holding back Article 6.4. Some of these issues revolve around methodological guidance on which projects should be credited. Removals. It's important to mention that carbon removals were not included in the Clean Development Mechanism under the Kyoto Protocol and to some extent Article 6.4 is looking to be a new and improved CDM 2.0.

So it is definitely borrowing from the CDM, but for instance, on this topic of carbon removals, it really needs to agree on new methodologies and also new rules. Around the removals, one of the key question is who is liable for carbon reversals? If we were to think for instance about a natural carbon capture project like let's say reforestation, the question is who would be liable for the reversal if for instance that forest were to be cut down or a fire were to burn the forest down? The question is would the developers be liable for this or would the host country government be liable?

Another question is currently around whether some activities which are deemed to be transformative in their climate action could potentially be exempted from raising an ambition over time. Because let's not forget under the whole Paris Agreement framework, countries have to raise ambition over time through their nationally determined contribution. So these are some of the key issues that have been delaying action in this market. It's worth noting that between COP27 and COP28, there have been a number of interim meetings by the supervisory body. The supervisory body for Article 6 is looking to advance technical discussions ahead of the climate negotiations, which will happen in December. Unfortunately, some of these technical discussions have not been advancing as quickly as they thought. So even if there is agreement on Article 6.4 at COP28, we may not see Article 6.4 units being released before 2025. So there's a lot of pressure building to have an agreement before COP28 and not further delay climate action.

Another major point of contention regarding Article 6.4 is the issue of a baseline contraction factor. Because the idea is that emissions reductions should be adjusted against a baseline which is based on historical levels of emissions and that needs to be adjusted downwards in order to make the targets more stringent. So a lot of developing countries are against the idea of a BCF, which is the baseline contraction factor, saying that it's not feasible. Firstly, just in terms of data collection, it's going to be a huge task because you have to get historical emissions data for various industries which are going to be covered under Article 6 for various countries. So many of them are saying that this is just a task which is going to be extremely difficult if this is introduced. Then there is the issue of avoidance credits because under Article 6.4 there is the inclination not to go for avoidance credits or rather not to have them included under Article 6.4. Which sounds quite utopian and idealistic because of course removals credits are the better quality credits, they're higher quality credits.

But a lot of the market participants are asking that we already barely have any removals credits in the market, we don't really have the infrastructure, methodologies are not in place, resources are not easily available to generate these removals credits as well. So it might be quite difficult to completely restrict the use of avoidance credits at least in the initial stages. So there's a debate over that as well. And then like Dana mentioned, the issue of CDM credits and how they're going to be transitioned into Article 6.4. Because as per what was decided in COP26, which was in Glasgow, they said that credits registered under CDM after January 2013 can be used for the country's first NDCs, which ends in 2030 for most countries.

But this would mean that about 300 million CDM credits would be eligible under Article 6.4. And especially again with the quality concerns that have permeated the carbon market, the question is whether these CDM credits which were issued are previously using older methodologies, which might not have been as stringent as methodologies in place today, will they dilute the value of this current market? These are a number of factors that are impacting negotiations because there's a lot of back and forth and not too much agreement over these factors as well.

Thank you both. That was a very nice summary of some of the key complex issues that still need to be ironed out. Now, as we know, the operationalization of Article 6.4 will provide a new structure in effect creating a new compliance market, opening up fresh demand for these credits, with obviously the UN deciding the rules on eligibility. But how is the voluntary carbon market viewing these discussions? We are hearing that it's likely to have a profound impact on many projects and carbon carbon credits. So can you tell us a little bit about the viewpoint of the industry in the voluntary carbon market and how they're viewing this?

You're absolutely right. We've heard a lot about how the future of the VCM depends upon the future of Article 6.4. And in fact in the voluntary carbon market, we know that there have been a lot of integrity attacks over the past year, in 2023, especially targeting the nature-based segment, which have to some extent hampered and cooled down demand. So when we look at the data in the voluntary carbon market to the end of October 2023, retirements of credits, which can be a measure of demand, were down 6% compared to what they were at October in 2022. So while the market is in a cooling down mode and wait and see mode, there's a lot of anticipation over the outcomes of the Article 6.4 discussions. There is a sense that if Article 6 is not agreed, then players can see carbon markets in general as carrying too much risk.

This in general can also threaten the long-term viability of a lot of the carbon markets that are currently in effect and to some extent that are being set up by a number of different countries. As you mentioned earlier, Article 6.4 will also have different profound implications on the voluntary carbon market. You can think that it could reduce supply in the voluntary carbon market because now you will not only have private project developers looking to generate voluntary carbon projects in a country, but you will also have countries needing to meet their NDCs through their local action and so they will also look to source supply internally. At the same time, it'll also increase demand because now it will not only be corporates looking to purchase voluntary carbon credits, but you will actually also see countries looking to meet their NDCs again.

These are some of the key variables that will have an impact on the VCM. Ultimately though Article 6.4 could potentially raise ambition for the voluntary carbon market. Some of the integrity attacks were specifically around a lack of quality. But to some extent, you can think that if a mechanism is being built under a UN framework, that would raise ambition, especially if buyers in the voluntary carbon market look to the methodologies agreed under Article 6.4 and also export those to the voluntary carbon market in turn. So there is a lot of anticipation, a lot of potential for the Article 6.4 to have an impact on the VCM. However, at the moment it's too early to say, we need to look at the outcomes of COP28 to have a better understanding of where the market will go into the future.

As a reporter covering the voluntary carbon market, what we've seen is a lot of confusion on the part of market participants. Because like with any market, everyone is looking to get the best price. So if you're a project developer for instance and you're looking at developing a project and none of these projects are easy to develop, they take years, carbon projects can take years to generate credits. So what we're seeing right now is people waiting and watching to see how Article 6.4 markets develop. If in the end they see that prices are better for Article 6.4 credits, we will see more players move away from the voluntary carbon market because they'll be able to sell at a high price. Similarly for buyers, a lot of voluntary buying is of course for net-zero commitments, to meet sustainability goals. And like Dana was saying, especially because of the issues around the voluntary carbon market, nobody wants to get stuck at this point with a portfolio of low quality credits which could later be questioned and criticized, as we've seen a lot of media articles do recently about various categories of credits.

So there is a stagnancy that has really hit the voluntary carbon market because they're waiting to see what's going to happen in Article 6.4. Now the problem is we are still waiting for concrete decisions in Article 6.4, which hopefully will happen at COP, but we don't have actual methodologies in place. Right now we have developers who are planning projects for Article 6.4, but that's just based on what they know so far, based on what they think the methodologies will look like. Developers are now looking to basically have credits that will be eligible both on Article 6.4, and if that doesn't work out, they'll also be able to sell it on the VCM. So that is causing confusion, stagnancy in the market and a certain slowness as well because people are right now waiting to see how Article 6.4 will develop.

Thank you both. Now moving to the price questionnaire, as we know, a lot of the carbon offsets currently are trading at very low levels, especially avoidance based credits. But what indications are we seeing on these Article 6.4 credits? Are they going to be trading at a premium to some of the already existing nature avoidance credits?

Well, yes, Eklavya, that is the indication that we are getting. The price of corresponding adjustment will be factored into Article 6.4 credits. So ideally, Article 6.4 credits should be priced higher than the VCM because you have that additional price of the CA adjustment. Now, the reason why this is so is that because when a country agrees to sell their credits, they have to substitute those credits through other emissions reductions. Because they will be selling those credits out of their portfolio, they'll not be able to include it in their NDCs, so they would need financial compensation for that. And that's the idea behind a corresponding adjustment premium.

Countries are doing it in different manners. Sometimes it's on a project to project basis according to the price indications we have been trying to get from the market. Some countries like Ghana for instance, we hearing that they're planning a set price for corresponding adjustment, which is about $5. So basically any credit which is being sold from the country of Ghana will be the price of the credit plus $5 for corresponding adjustment. Again, because everything is still very new right now, countries might change the mechanisms, developers might change their prices as well on per project negotiation basis. But yes, ideally to answer your question, the corresponding adjustment factor should increase the price of credits as compared to the voluntary carbon market.

Thank you. And now moving to Article 6.2, Dana, can you tell us a little bit about the current status really of this mechanism and which are the countries that are currently very active in Article 6.2?

So Article 6.2 is a very different story from Article 6.4. As was mentioned at the beginning, what Article 6.2 is trying to do is basically to create an accounting framework to allow countries to bilaterally trade these Internationally Transferred Mitigation Outcomes, which really are carbon credits, but under the UN framework. Article 6.2 at the end of COP27 was deemed to be largely operational, although some issues still remain. But in fact, as you say, a lot of countries have begun engaging in this market by signing bilateral agreements or MOUs.

So one of the main country on the buyer side has been Switzerland. Switzerland was actually the first mover in this market when it's signed an agreement with Peru. South Korea and Singapore are some of the other main buyers and we're also seeing Sweden and New Zealand on the buy side. When we look at supplier nations, Ghana is definitely one of the main countries that is considered to have a higher readiness for participating in Article 6 transactions. And in fact, we're also seeing several countries in Africa currently developing their Carbon Market Policy frameworks to plan for Article 6 engagement. Outside of Africa, we also see high activity on the supply side in Thailand, Mongolia and Colombia in South America.

Thank you, Dana. And Vandana, I would like to ask you about some of the outstanding issues really about Article 6.2, and can you also touch upon the price trends that you're seeing in this market?

Absolutely. Thank you, Eklavya. Like Dana mentioned earlier, the countries are already actively getting into bilateral agreements. This market is very active and we at S&P Global Commodity Insights have already reported a number of prices of Article 6.2 credits. The prices that we've heard for cookstove credits have been in the $20 to $25 per MTCO2e range. And for renewable energy credits under Article 6.2, they've been indicatively heard at about $10 per MTCO2e. So if you compare them to prices in the voluntary carbon market, they are higher, but important to note that many of these prices for Article 6.2 credits are forward transactions as well. For example, we reported a trade by Senegal to Switzerland, which was for a 500,000 MTCO2e every year till 2030 at a $22.50 MTCO2e fixed price. So every year at that specified volume, 500 MT credits will be sold at 22 and a half dollars.

Now, regarding the issues around Article 6.2, while covering the VCM, I've had a lot of interesting conversations with market participants at the S&P Global Paris Conference that took place. A number of participants there as well highlighted issues with Article 6.2. One of the main things is the lack of transparency in bilateral agreements. Because this is an agreement between two nations, there is no standardization, the terms and conditions completely depends on what is decided between the two countries. Many of our sources have highlighted that there is no incentive for stringency as there's no neutral overseeing body. And there've also been concerns highlighted that the same quality issues that we've seen come into the VCM, we might see them in Article 6.2 if something is not done to address that. Of course, right now at the COP28 Summit, which is expected in Dubai, we hope that there is further clarity on Article 6.2 and these issues are sorted out.

But at the same time, these are serious concerns. For example, one of our market sources was asking what really prevents a government and a shady buyer from getting into a deal? Then when you have governments in the picture, what happens with elections? When there're changes in government, what happens if, for example, corresponding adjustment is granted for one project and later it is revoked, there could be complete chaos. So there are a lot of these issues which really need to be streamlined in the next COP hopefully. Another issue that's been highlighted is that unlike in the VCM where you have these certain standards like Verra Gold Standard, et cetera, which oversee the issuance of credits because this is happening on a country to country basis. The host country will obviously be interested in profits, they'll be interested in selling their credits to a buyer country. The buyer country will be interested in making their NDC targets. So once again, there's no proper incentive for quality. So unless basically these agreements and these emissions reductions rather are handled by experts in neutral parties, we can see quality issues come into the Article 6.2 space as well.

Yet another concern is the fact that not all countries have the same know-how, not all countries have the same resources. For example, I was at the West Africa Carbon Markets Hub and there were a lot of countries, there were representatives from many countries over there who came up to us, asked about our Platts prices, they wanted to know more about it because they said they had no idea what price to sell credits at, how to negotiate prices with a buyer country because there's just not too much information. Many of these countries are dealing with nations who have established ETSs, who have been dealing in the carbon market for decades and they're just entering the market completely fresh and new, still trying to grasp these very complicated concepts. That is a challenge as well under Article 6.2. A lot depends on what happens at the next COP and hopefully these issues will be addressed because otherwise we might see a number of problems come into this marketplace as well.

Thank you both for your insight. This really shows that much still needs to be done to really advance the key pieces of the international trading and the touting framework, especially under Article 6.4. And it's not only the commodity and energy markets that will be keeping a close eye on these developments, it's pretty much every industry and government that will be following what's going on in Article 6 under the Paris Agreement. There are a lot of hopes pinned on COP28 and many critical decisions need to be taken. At S&P Global Commodity Insights, we will be keeping a close eye on these developments from our pricing, analytics and news teams.

Thank you very much for joining me in this conversation and thank you to our listeners for tuning in. If you're attending COP28 in person, you have the chance to join our inaugural S&P Global Commodity Insights COP28 Forum, taking place on November 29th at the Hilton Dubai Palm Jumeirah in Dubai. This year the event will focus on the theme of energy transition, strategic choices and demonstrating progress. Don't miss out on the conversations that will shape COP28. Save the date, we hope to see you there. This Future Energy Podcast was produced by Felix Fernandez in London.