As highlighted in December’s Carbon Watch, the 29th UNFCCC Conference of Parties (“COP29”) held in Baku, Azerbaijan last November marked real progress towards implementing the Paris Agreement’s Article 6 carbon market mechanisms, which are expected to unlock large-scale financing for global climate mitigation. COP29 fully authorized and operationalized the two major carbon market mechanisms under Article 6, establishing a registry and rules for international carbon credit trading. We believe this is the most significant outcome for international carbon markets since COP26 in Glasgow back in 2021, and as such wanted to highlight this development more closely.

Importantly for market participants, agreements at COP29 finalized the rulebook and critical structures for full operationalization of Article 6.2 and 6.4 carbon markets. The parties agreed on final rules to facilitate the measurement, transfer, and trading of greenhouse gas emission reductions bilaterally between countries, known as Internationally Transferred Mitigation Outcomes (“ITMOs”) - the carbon credit unit of Article 6.2.  This should further promote confidence in existing market mechanisms under the Article 6.2 umbrella, such as the Japan Crediting Mechanism (“JCM”) and Singapore’s compliance carbon tax that links to offset credits issued under Singapore’s 6.2 treaties.

Still more significantly, however, COP29 gave full authorization to a new carbon crediting mechanism under Article 6.4, now called the Paris Agreement Crediting Mechanism (“PACM”). The PACM is a full redesign and replacement of the Kyoto Protocol’s legacy compliance offset program known as the Clean Development Mechanism (“CDM”) and eventually should scale to deliver larger volumes of carbon abatement and credit supply than the CDM market or any existing offset program. The PACM is a comprehensive program that includes a self-standing carbon registry which will serve as a repository for emissions reduction data from specific carbon projects and “issue” transferable credits. The PACM also will develop and establish a set of carbon quantification methodologies, or offset protocols, approved by the UN regulatory process. This should help address quality concerns that have plagued the voluntary carbon market in recent years in absence of compliance offset programs operating at scale.

These two new Article 6 frameworks, fully authorized by countries at COP29, are expected to unlock capital deployment at a larger scale for crucial decarbonization projects, particularly in low income and emerging market countries. ECP expects that this will lead to exciting capital deployment opportunities as developers build projects to supply global demand for these units. These demand sources include the Carbon Offsetting and Reduction Scheme for International Aviation (“CORSIA”), national regulatory mechanisms like JCM, and tax-based decarbonization strategies that use ITMOs for alternative compliance, such as Singapore’s carbon tax. We expect that these developments will lead over time to more commoditized carbon instruments that allow investors dynamic exposure to a global carbon price derived from projects with tangible emission reduction/removal impacts, while also providing crucial liquidity to markets.

Since Baku, there are continued signs of market activity in carbon units expected to be eligible for international transfer under these two Article 6 mechanisms. Project developers are preparing to generate credits under the PACM, and eligible CDM projects are gearing up for transition into the new system. Meanwhile, credits from voluntary carbon projects with Letters of Approval from host-country governments continue to transact in over-the-counter markets as the broader transfer framework takes shape.

Of course, these achievements of COP29 happened following (and perhaps partly as a consequence) of the U.S. elections and the prospect of the new Trump Administration pulling the United States out of the Paris Agreement. While this would cast considerable doubt about America’s role in global climate mitigation going forward, we expect this to have limited impact on the development of Article 6 carbon markets given that almost all other countries will continue to be part of the Paris Agreement.  

There are currently parallels to previous cycles of U.S. climate policy changes, both in 2017 when the previous Trump Administration first pulled out of the Paris Agreement, but perhaps even more notably back to the early 2000s, when the George W. Bush Administration pulled the U.S. out of the Kyoto Protocol. This latter event occurred just after the agreement of the Kyoto/CDM rulebook at COP7 (the “Marrakesh Accords”), and the U.S. went on to subsequently exit the international carbon markets while the rest of the world moved forward with the CDM market mechanism.

That event laid the groundwork for the original birth of the voluntary carbon market, precisely to allow countries that were outside of the Kyoto Protocol (the United States, Canada, Australia, Hong Kong and more at that time) to develop and fund carbon reduction projects driven by voluntary and corporate activity. With the Paris Agreement absorbing all supply-side activity under participating countries, should the U.S. in fact go on to exit the Paris Agreement, this could lead to the outcome of the voluntary carbon market becoming a U.S.-centric market, while the rest of the world proceeds with the compliance carbon markets under Article 6.