The human side of the carbon market

The 26^thConference of Parties (COP26) held in Glasgow last year created significant momentum on climate action, most notably through enhanced net-zero emission pledges, climate mitigation and adaptation finance targets, and revival of international carbon markets.

Since then, there has been much talk on how international carbon markets can play a role in the broader climate policy architecture, and whether or not they can serve as an instrument to tackle the climate crisis.

The global climate community remains divided on the matter. Proponents of market-based mechanisms argue that the scale of the climate action cannot be achieved without the use of carbon markets. Others argue that carbon markets simply aid to avoid the problem and help the polluters find a scapegoat to keep on polluting –– while creating “green or carbon washing”.

This debate is not new and this is also not the first-time international carbon markets are at the centre of the fight against the climate crisis.

Under the Kyoto Protocol (the Paris Agreement’s predecessor climate treaty) international emissions trading was a key feature and developing countries would participate through the Clean Development Mechanism (CDM) which mobilised carbon finance at scale and helped diffuse advanced low carbon technologies in developing countries, incentivising the implementation of mitigation actions and transfer of climate finance through the sale of carbon credits to developed countries.

At the same time, it was controversial for human right violations, quality of carbon credits being sold, and the eventual crash of the market in the mid 2010s, leading to reduced faith in international carbon market mechanisms such as CDM.

So why are carbon markets back at the centre of the climate discourse, and what does it mean for the battle against the climate crisis?

Carbon markets remain a popular instrument both for economists who have advocated their use as a cost-effective instrument to mitigate greenhouse gas emissions as well as policymakers who remain particularly appealed by its ability to generate revenue. They are less politically challenging, for example when compared to a carbon tax, and are a flexible instrument that can be designed to suit national circumstances and priorities.

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They can be varied in scope, design and coverage, and they also exist in different forms. A simplistic classification of carbon market types includes domestic cap-and-trade systems (commonly referred to as an emissions trading system), and baseline-and-crediting mechanisms, including international carbon markets under Article 6 of the Paris Agreement and the voluntary carbon market.

There is a growing momentum to utilising both types of carbon markets, with many more jurisdictions adopting emissions trading system and a growing market for both Article 6 and the voluntary carbon market.

The carbon market is only going to increase as countries scramble to take advantage of instruments that can tackle the climate crisis without putting fiscal pressure on the economy. Another demand comes from net-zero pledges which will require carbon credits to fulfill. However, carbon markets are not a panacea, and we need to ensure they are designed in a way that benefits the people and the planet.

The devil is in the details.

While it seems inevitable that carbon markets will scale-up, uncoordinated efforts might do more harm than good. The value chain of carbon markets comprises multiple players across a broad range of layers which makes them difficult to navigate.

A focus on generating carbon credits to sell in the market without putting beneficiaries at the centre of the project design can create detrimental impact. This is a heated issue in the carbon market debate, particularly with regards to how countries and companies will account for the purchased credits. The challenges seen under the carbon markets in Kyoto Protocol, related to treatment of human rights and indigenous communities, will need to be addressed.

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A major controversy that has emerged concerns the export of carbon credits and how they will be accounted for. For example, if a corporation claims carbon credit for offsetting while the emission reduction will also be counted to the host country's nationally determined contribution (NDC) in the Paris Agreement, it is a form of double claiming.

To counter this, some independent carbon crediting programs have proposed an approach where a company with voluntary net zero targets may choose to purchase carbon credits backed by national accounting or purchase units that represent a 'contribution claim', i.e., supporting the host country’s NDC by financing mitigation outcomes, but not claiming the emission reductions for its own voluntary or net zero target.

Despite these technicalities and concerns that surround international carbon markets, it is inevitable that carbon markets will only grow.  However, a ‘beneficiary centric’ approach to carbon markets is imperative.

Many of the world’s most important carbon sinks are on land inhabited by indigenous communities. For the carbon market as well as indigenous communities to flourish, the rights of those communities must be secured. It will be important to humanise the carbon market and ensure that beneficiaries can be put at the heart in market design.

But this is easier said than done. The discourse on carbon markets tends to be technical, rummaged by financiers, bankers, engineers, and consultants. Given the technicalities around carbon markets, what does it mean to utilise a ‘beneficiary centric’ approach is tough to answer. Yet, it must be answered, thought through, and implemented.

Efforts are underway, but conversations need to be more inclusive. Inputs from women, youth, and marginalised and vulnerable groups including indigenous communities will be critical despite their perceived lack of technical knowledge on this subject.

Environmental non-governmental organisations will have to play a stronger role in ensuring accountability in carbon transactions, and governments and intergovernmental bodies will have to ensure carbon markets work in the highest level of integrity.

There are good examples for this: both the Article 6 rules adopted at COP26 in Glasgow, and the Carbon Core Principles from the Integrity Council for the Voluntary Carbon Market, are ambitious. But humanising the carbon market will be difficult –– not just to implement and monitor, but to decode.

Given the financial scale carbon markets can reach, they will have to play a part in funding climate adaptation and loss and damage, above and beyond the international requirements for the carbon market’s contribution to adaptation. This is in addition to their role as a channel of finance for the countries hosting carbon crediting projects.

Furthermore, carbon credits cannot only be looked at as a commodity for the buyers. Innovation and imagination are required on what can be done.

Carbon banks can be established which could provide low-interest micro loans to beneficiaries using carbon assets as a collateral. This needs to be complemented by financial contracts that cater for beneficiaries and help them retain a certain amount of carbon credits.

The agriculture industry accounts for almost one-fourth of global emissions, yet only around 2% of climate finance flows into it. Linkages between carbon markets and agriculture need to be strengthened, and the financing needs to be scaled up such that not just farmers being impacted by climate crisis can be supported but also methane emissions from the agriculture sector can be brought down.

Carbon markets have potential, but they need to be unleashed in a way that is inclusive and just. It is integral to put beneficiaries at the heart of any carbon transactions and rethink the overall goal of carbon markets in the first place.

Rastraraj Bhandari and Johan Nylander, PhD work in operationalising carbon market instruments including Article 6 of the Paris Agreement and the Voluntary Carbon Market.