Centuries of uncontrolled industrialisation has led to an increase in atmospheric carbon dioxide levels from pre-industrial era of 172 ppm to 417 ppm, leading to climate change and increased frequency and intensity of extreme events. Since the 1990s, there has been increasing scientific evidence and global concern on the impact of climate change. Based on scientific inputs complied through the reports of the Intergovernmental Panel on Climate Change (IPCC), effective and binding legal instruments like the United Nations Framework Convention on Climate Change (UNFCCC) have been instituted.

Carbon markets help in tackling greenhouse gas (GHG) emissions by enabling the trading of emission units, and further aid in lowering the economic cost of reducing emissions. The Kyoto Protocol (KP) has mandated country-level limitations or reductions in GHG emissions. Carbon markets have not only played a significant role in mitigating climate change but also in building capacities globally as was evident in the pre-2020 era under the KP’s flexible market-based mechanisms and, more significantly, under the Clean Development Mechanism (CDM).

The Paris Agreement, which aims to keep global average temperature rise to well below 2oC from pre-industrial levels, kicked in on January 1, 2021. This agreement has given a fillip to the market-based mechanisms after a long lull of almost eight years since January 1, 2013. With the end of the second commitment period of the KP on December 31, 2020, countries are jostling amongst themselves to ensure that rules and a framework are decided upon in the working of Article 6 of the Paris Agreement, which deals with carbon markets for the new regime.

Article 6 of the Paris Agreement has three key clauses: (a) Article 6.2 states an accounting framework for international cooperation, allowing for international transfer of carbon credits between countries; (b) 6.4 sets up a central UN mechanism to trade credits for emission reduction in certain projects; and (c) 6.8 provides for a work programme for non-market approaches.

There are sticking points related to Article 6 due to which rules and procedures have not been finalised for the larger carbon-market framework. The finalisation of the rules of the Paris Agreement was postponed due to the Covid-19 pandemic. The fate of the new carbon market framework to be adopted thus hangs in balance until COP26 at Glasgow this year.

One of the key contentious issues leading to delay is the fate of several unsold tradeable carbon credits generated under the CDM. The project developers in developing countries have not been able to realise significant revenues due to a decline in credit prices resulting from the restrictions on their use in the European Union carbon market.

Countries are still negotiating, and UNFCCC is yet to finalise the knowhow of the transition mechanism of these credits under Article 6 of the Paris Agreement. The transition of carbon credits from Kyoto to Paris is an important aspect for countries like India, China and Brazil as they occupy the largest share of the global carbon market with huge amounts of unsold credits. Lack of agreement on the rules of the Paris Agreement will have consequences in terms of double counting or claiming of emission reductions. Other issues include carry-over of Kyoto credits as there are excess credits of about four billion units unsold due to a lack of demand. Arguably if these credits are used to meet NDC targets, mitigation ambitions under the Paris Agreement would be reduced.

San Jose Principles

As a response, a group of 32 countries, mainly consisting of the EU and its allies tabled the San Jose Principles for High Ambition and Integrity in International Carbon Markets at COP25 in 2019. One of these principles ‘prohibits the use of pre-2020 units, Kyoto units and allowances, and any underlying reductions toward Paris Agreement and other international goals’ which would not be amenable to countries such as India, Brazil and China.

It is interesting to look at the composition of the group of countries that signed the San Jose principles and to see what stake they have in the global carbon market mechanism. The group of 32 countries includes 12 from developing and least developed categories and they together account for 150 CDM projects with total emission reductions of 20.02 million credits many of which have been sold or voluntarily cancelled.

The remaining countries are mainly the EU countries that do not lose potential revenue on signing of the San Jose principles. A country like India would find it challenging to be a party to these stated principles as it has several unsold carbon credits that need transitioning in the post 2020 carbon markets. There are various estimates of almost 400 million unsold credits from projects registered under CDM from India. Paying for previously achieved emission reductions practically do not limit countries to support ambitious mitigation goals.

The San Jose principles, though noble in intention, do not really throw light on concerns of developing countries over loss of potential revenue. Pre-2020 credits constitute an important part of their own finance requirements in pursuance of the goals of the Paris Agreement. Locking in of technologies and practices, amongst others, put immediate pressure on developing countries and do not allow them to transition.

Moreover, these principles lack geographical spread in terms of adoption. The 32 countries that signed represent mostly the countries of the EU, as a block. There is a definitive lack of engagement of Asian, African, South American and North American countries.

With the rules for the operationalisation of the carbon markets under Article 6 of the PA yet to be finalised, it is important to understand how carbon markets are going to function in this decade.

The San Jose principles’ lack of widespread international support highlights that these must be fine-tuned so as to receive the general consensus any international rules based order deserves. The principles must consider issues of countries like India, China and Brazil who have been active participants of carbon markets in the past.

Burnwal and Gaurav are Technical Advisors, Climate Change, GIZ India; Bhatt is an advocate and independent consultant