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Climate Action Through Carbon Markets

As a follow-up to the Paris Agreement in 2015 which set out ambitions to limit global warming to 1.5°C, nations and global businesses convened in Glasgow last month for the 26th Conference of the Parties (COP26). The resulting Glasgow Pact set out a rulebook to operationalize some of the pledges and targets announced in Paris. A key highlight of the outcomes surrounded Article 6 of the Paris Agreement, paving the way for the development of a global carbon market.

Global carbon markets are not new; trading of carbon emissions and credits have been ongoing for decades. What’s been missing were stringent accounting rules on how to calculate those emissions that are traded. Current carbon markets are exposed to considerable price variability and uncertainty. There is no standardized verification criteria and therefore no certainty when purchasing carbon credits. The Paris Rulebook addresses some of these issues, including the issue of double counting of carbon credits. This is expected to provide more transparency and reliability through authorized “exports’”of offsets.

Like me, you may be asking “what’s the deal with Article 6?” Why is carbon trading getting all this attention when real, tangible reductions in emissions are needed to avoid disaster? The answer is cost. According to the Environmental Defense Fund, employing global emissions trading to meet Paris Agreement pledges could reduce total mitigation costs by up to 79 percent. Reinvesting these cost savings into greater emissions reductions would nearly double the cumulative emissions reductions from 2020-2035.

And these costs are significant. According to energy expert Daniel Yergin, the current energy transition will be much more challenging than the energy transitions of the past in order to successfully mitigate and adapt to climate change. Previous transitions — from wood to coal or from coal to oil — have been additive, i.e., “one source atop another.” However, this transition should be an almost complete switch from the energy basis of today’s $86 trillion world economy, which gets 80 percent of its energy from hydrocarbons.

The financial strains of climate action and the energy transition are felt significantly by developed countries and even more so by developing nations, where major climate events are even more pronounced and mingled in with the recovery from COVID-19, improving health, reducing poverty and maintaining social stability. “[The] energy transition itself is multidimensional” and must take “into account the different realities of various economies and accommodate various pathways to net zero,” says Nigeria’s Vice President, Yemi Osinbajo.

Global carbon market trading volumes reached over $1B in 2021. Wood Mackenzie believes this will continue to increase significantly, with high price variability in the near term. In the medium term, as national markets determine how they will interact with the global pricing mechanisms set out in Glasgow, variability of standards and quality will result, creating a price wedge between high-quality credits and low-quality credits. With demand for high-quality credits increasing, as pledged companies and countries aim to meet their ambitions with solid and trustworthy credits, variability will lead to a steady increase in value, while simultaneously reducing the volume of carbon credits available for trading (and meeting the main objective of reducing carbon being emitted).

“By definition [COP] is an exercise in diplomacy” says Helen Bertelli, president and co-founder of Women in Climate Tech, “it sets expectations that it alone cannot meet.” Most political leaders lack the ability to enforce change on private industry; however, private industry and private capital are going to be key and will play a critical role in doing the work if we are to meet the targets set out.

Taking a historic example for comparison, Corporate Average Fuel Efficiency standards were enacted in 1975, to which Henry Ford II acknowledged “the law requiring greater fuel efficiency in motor vehicle usages has moved us faster towards conservation goals than competitive, free-market forces would have done.” Indeed, similar sentiment is shared by current-day enterprises. In 2019 Shell announced a Path to Net Zero Emissions by 2070, then revised its roadmap to meet Net Zero Emissions by 2050 in Spring 2021. To this, a Dutch court imposed stricter mid-term carbon emission reductions for Shell, its suppliers and customer — by 45 percent by the end of 2030 compared to 2019 levels. Experts speculate that these restrictions will result in Shell’s divestiture, through sale of assets to smaller, less scalable operations that may potentially result in overall net-positive emissions. However, the point still stands; set targets and regulations with consistent and accurate monitoring will ensure a healthy and lucrative global carbon market, with real emission reductions in the long term.

Next steps require improvements in national carbon markets. With the development of a regulatory framework on FERC Order 2222 on its way, and the US Securities and Exchange Commission preparing Climate Disclosure criteria, there is an opportunity for the Energy Transition in the United States to lead the charge in global carbon market standards and climate change cost mitigations.