Carbon PricingUsing Market-based Mechanisms to Mitigate Climate Change

Imprint

Published byFederal Ministry for the Environment, Nature Conservation, Building and Nuclear Safety (BMUB)Division KI I 6 · 11055 Berlin · GermanyEmail: KII6@bmub.bund.de · Website: www.bmub.bund.de/english

Edited byDr. Silke Karcher, BMUB, Head of Division KI I 6 · Malin Ahlberg, BMUB, Division KI I 6

Technical editingWuppertal Institute for Climate, Environment and Energy (Wuppertal Institut für Klima, Umwelt, Energie gGmbH) Research Group: Energy, Transport and Climate Policy

TextNicolas Kreibich and Lukas Hermwille

DesignSelbach Design, Lohmar

Printed byRautenberg Verlag, Troisdorf

Picture creditsFront page: Flickr.com | Philippe Roos 'Ain-Beni-Mathar-2010-10-27-005' (CC BY-SA 2.0 –www.flickr.com/photos/elisaphi/5860954697/);  page 3: Flickr.com | UNFCCC: 'Country Flags outside the conference venue' (CC BY-NC-SA 2.0 –www.flickr.com/photos/unfccc/30563098030/); page 4: Flickr.com | UNFCCC: 'Her Excellency Ms. Angela Merkel, Chancellor of Germany'(CC BY 2.0 – www.flickr.com/photos/unfccc/23129752020/); page 5: Flickr.com | World Bank | Jutta Benzenberg : 'Green Energy' (CC BY-NC-ND 2.0 – www.flickr.com/photos/worldbank/32519834310/); page 6: Flickr.com | World Bank | Dana Smilie: 'Thermo-solarpower plant' (CC BY-NC-ND 2.0 – www.flickr.com/photos/worldbank/4842168024/); page 7: Flickr.com | World Bank | Graham Crouch:'Northwest Kabul Breshna Sub Station' (CC BY-NC-ND 2.0 – www.flickr.com/photos/worldbank/8120062723/); page 8: Flickr.com | BASF: 'Stammwerk der BASF Gruppe – Ludwigshafen / Headquarters of the BASF Group – Ludwigshafen' (CC BY-NC-ND 2.0 – www.flickr.com/photos/basf/15970551636/); page 9: Flickr.com | Global Landscapes Forum: 'Bangui Wind Farm' (CC BY 2.0 – www.flickr.com/photos/152793655@N07/33465251872/); page 10: Flickr.com | UNFCCC: 'they did it!' (CC BY 2.0 –www.flickr.com/photos/unfccc/23692333176/); page 11: ENB/IISD | Kiara Worth (enb.iisd.org/climate/sb46/enb/13may.html); page 13: ENB/IISD | Kiara Worth (enb.iisd.org/climate/sb46/enb/11may.html); page 15: Flickr.com | Stuart Rankin: 'Fertilizing Fields' (CC BY-NC 2.0 – www.flickr.com/photos/24354425@N03/14576896108/); page 18: Flickr.com | BASF: 'Sustainable construction in Dubai' (CC BY-NC-ND 2.0 – www.flickr.com/photos/basf/8725203241/); page 19: Flickr.com | UNFCCC: 'The SBSTA opens its work in plenary' (CC BY-NC-SA 2.0 – www.flickr.com/photos/unfccc/34528730525/); page 20: Flickr.com | International Monetary Fund: 'SM16 Carbon Pricing Leadership Coalition Meeting' (CC BY-NC-ND 2.0 – www.flickr.com/photos/imfphoto/26447249875/); page 21: Flickr.com | BASF: 'Stammwerk der BASF Gruppe – Ludwigshafen / Headquarters of the BASF Group – Ludwigshafen' (CC BY-NC-ND 2.0 – www.flickr.com/photos/basf/15970551746/); page 25: Flickr.com | Naoya Fujii: 'Kobe Airport' (CC BY-NC 2.0 –www.flickr.com/photos/naoyafujii/3277240558/); page 26: Flickr.com | International Monetary Fund: 'SM16 Carbon Pricing LeadershipCoalition Meeting' (CC BY-NC-ND 2.0 – www.flickr.com/photos/imfphoto/25842392044/); page 28: Flickr.com | CIFOR | M. Edliadi: 'Danum valley canopy walk' (CC BY-NC-ND 2.0 – www.flickr.com/photos/cifor/35850275316/); page 29: Flickr.com | CIFOR | M. Edliadi: 'Plant nursery' (CC BY-NC-ND 2.0 – www.flickr.com/photos/45423546@N07/35891043385/); page 30: Flickr.com | Global Landscapes Forum: 'Pollution – Thermal power plant at Sarni, Betul District, Madhya Pradesh, India' (CC BY 2.0 –www.flickr.com/photos/152793655@N07/33579276626/); page 31: ENB/IISD | Kiara Worth (enb.iisd.org/climate/sb46/enb/11may.html)

DateSeptember 2017

Second Print500 copies

Where to order this publicationBMUB, Division KI I 6 · Email: KII6@bmub.bund.de

NoticeThis publication is part of the public relations work of the Federal Ministry for the Environment, Nature Conservation, Building andNuclear Safety. It is distributed free of charge and is not intended for sale. Printed on recycled paper.

3

Contents

4 Introduction

6 The Need for Carbon Pricing

10 The Paris Agreement:

International Cooperation for Raised Ambition

20 Price-based Climate Change Mitigation Efforts Worldwide

30 The Future of the Global Carbon Market:

Open Issues on the Road to Implementation

4 Using Market-based Mechanisms to Mitigate Climate Change

Carbon Pricing

The international community is working apace inefforts to mitigate climate change and adapt to itsunavoidable effects. Just a year after the Parties con-cluded the world’s first global climate change agree-ment, the Paris Agreement entered into force onNovember 4, 2016. This was made possible because theAgreement was ratified in record time. The willingnessto set about implementing the measures agreed in Parisin 2015 was also stressed in Morocco at the first Confer-

ence of the Parties to the Paris Agreement. The Mar-rakech Action Proclamation makes it clear that fromnow on, the focus is on implementation and action.

But before the Agreement’s implementation can begin,there are a number of implementation-related issueswhich need to be clarified and are to be laid down in a Paris Agreement rule book. The Parties have giventhemselves until the end of 2018 to finalise the

Introduction

Using Market-based Mechanisms to Mitigate Climate Change 5

rule book’s content. The still-to-be-agreed rules affectthe new international market-based mechanisms contained in Article 6 of the Paris Agreement. Onceaccounting issues have been clarified and implementa-tion rules agreed, these mechanisms will offer Parties a wide range of options for bilateral cooperation. Miti-gation outcomes can be transferred between the statesand used to meet nationally determined contributions(NDCs). This provides the basis for a new global carbonmarket for the post-2020 period.

Beyond the United Nations Framework Convention on Climate Change (UNFCCC) arena, efforts are alsounderway to use market-based tools to put a price onclimate-damaging activities and thus develop afford-able emission reduction potential. Use of carbon pric-ing instruments is gaining ground on a global scale:some 20 countries now have carbon tax programmes inplace. Emissions trading schemes have been introducedin 36 national jurisdictions. Carbon pricing initiatives are being pursued at sub-national level too: in NorthAmerica, Ontario and Alberta have recently introducedpricing instruments for harmful emissions. These useinnovative approaches to enable interaction betweendiffering administrative levels. For example, Canadahas introduced a national framework under which alljurisdictions are required to introduce a greenhouse gas taxation programme by 2018. The combination of arange of different instruments continues to play animportant role: the greenhouse gas tax introduced inColumbia is expected to enable use of emission reduction certificates.

Use of certificates to offset unavoidable emissions isalso the core component of the Carbon Offsetting andReduction Scheme for International Aviation (CORSIA)mechanism introduced by the International Civil Avia-tion Organisation (ICAO) in October 2016. To make the

aviation sector’s rapid growth carbon neutral from2020, use of offset certificates is to be enabled. The ruleson using the mechanism are expected sometime inautumn this year.

Germany is actively involved in the technical design ofthese international climate change mitigation instru-ments and is driving the dynamic development ofprice-based instruments at government level. Forexample, the Federal Government made climatechange a focal topic of its G20 presidency. With theexception of the US, all G20 states explicitly committedto the Paris Agreement and its implementation. Withthe G20 Action Plan on Climate and Energy for Growthan instrument was agreed which provides a wide rangeof cooperation measures concerning energy and climate policy, and fosters dialogue on market-basedmitigation tools.

This brochure gives an overview of the various carbonpricing approaches, explains how they work and out-lines the progress made in their development so far.

6 Using Market-based Mechanisms to Mitigate Climate Change

Carbon Pricing

The Need for Carbon Pricing

Climate change is one of the central challenges facedby society in the 21st century. The effects of man-madeclimate change are already being felt: 2016 was thewarmest year since temperature recording began. Thismakes it the third record year in succession after 2014and 2015.1 In October and November 2016, the icesheet covering the Arctic Ocean was thinner than everbefore and the Antarctic had the smallest ice sheet seento date. Extreme weather events are becoming far morefrequent and far more intense. Climate change isalready seriously affecting societies around the world.

To mitigate climate change and coordinate efforts todeal with its effects, the international communityadopted a new climate change agreement in Paris inDecember 2015. Under that agreement, the 194 Partiesto the United Nations Framework Convention on Cli-mate Change (UNFCCC) committed to limiting globalwarming to well below two degrees Celsius above pre-industrial levels and to pursue efforts to limit thetemperature increase to 1.5 degrees Celsius.2 Thanks tothe quick ratification of the Paris Agreement by a largenumber of Parties, the Agreement went into effect onNovember 4, 2016 – far earlier than expected by eventhe most optimistic observers. The Paris Agreement’sprovisions will be applied from 2020.

Carbon pricing as a market signal forindustry However, the emission reduction targets submitted byParties so far – known as nationally determined contri-butions (NDCs) – are not enough to meet these goals.Around the world, greenhouse gas emissions are stillfar too high. One of the reasons is that emitters, thosewho cause the emissions, are not required to cover thecosts of climate change. The damage caused to the cli-mate equates to external costs that are not included inthe price of a tonne of coal, a barrel of oil or a cubic

metre of gas. Putting a price on carbon can change allof that.3

If an appropriate price were to be charged for everytonne of CO2e emitted, it would send a signal to busi-nesses and consumers, helping them to give greaterconsideration to climate change in their production,investment and purchasing decisions. Carbon pricingalso makes it easier to implement climate change miti-gation measures because the price signal it sends helpsto ensure that emissions are reduced in those areaswhere cost-savings can be achieved.

Price-based climate change mitigation mechanisms arenot just an idea, but reality. Around the world, they arebeing used at various levels and in different forms. TheEU Emissions Trading Scheme (EU ETS) is perhaps thebest-known example. Alongside emissions tradingschemes, many different instruments are now in place,including various forms of greenhouse gas (carbon)taxes and crediting mechanisms which are used to certify emission reductions and make them tradable.

An emissions trading scheme sets a regulatory ceilingor ‘cap’ on greenhouse gas emissions in industrial sec-tors. Within the sectors covered by the scheme, only alimited quantity of emission permits (allowances) areissued, namely just enough to allow the reduction target to be met.

1 www.ncdc.noaa.gov/sotc/global/2016132 Paris Agreement, Article 2.3 Where mention is made of a carbon market or carbon pricing, this

also includes other greenhouse gases. Apart from carbon dioxide,these include methane (CH4), nitrous oxide (N2O) and a range ofindustrial gases (HFKW, PFKW und SF6). The effects these farmore potent greenhouse gases have on the climate is calculated inCO2-equivalents (CO2e), placing them in a common unit that isequal to the sum of CO2 emissions over a period of 100 years.

Using Market-based Mechanisms to Mitigate Climate Change 7

8 Using Market-based Mechanisms to Mitigate Climate Change

Carbon Pricing

Each business covered by the emissions trading schememust possess an allowance for each tonne of CO2e they emit. These companies are either issued a portionof the necessary allowances free of charge or they can purchase them by auction from the state. Theseallowances can also be freely traded. This allows thecompanies involved to buy additional allowances or, ifthey have succeeded in reducing their own emissions,to sell excess allowances they no longer need. This givesrise to a uniform carbon price, which in turn serves asan important market signal. The companies covered by the emissions trading scheme can then considerthat carbon price in their short-term managementdecisions and long-term investment planning. Theprice depends largely on the level of ambition appliedwhen setting the upper ceiling of the respective emis-sions trading scheme and on the costs incurred by the companies in implementing their emission reduction measures.

Greenhouse gas or carbon taxation levies a predeter-mined tax rate for each tonne of CO2 emitted. Taxationof this kind also puts a price on emissions, sending asignal to companies covered by the taxation scheme toreduce emissions in the shorter term and make theirlong-term investments climate friendly. In contrast toemissions trading schemes, there is no trading involvedand very little flexibility is afforded to businesses as aresult. While an emissions trading scheme determinesthe absolute quantity of emissions, carbon taxation

defines the price of the emissions. But although a taxa-tion system ensures a stable carbon price, it cannotguarantee that the emission reduction targets set forthe sectors involved will actually be met. The incentiveis largely dependent on the taxation rate charged: if it is high, it provides an incentive to keep emissions low.

Crediting mechanisms exist outside the regulatedworld of emissions trading and carbon taxation. A crediting mechanism can either be based on individualclimate change mitigation projects or be designed tocover entire industries or industry sectors. With thistype of mechanism, tradable certificates are issued foractual emission reductions achieved. Certificates areissued when actual emissions are reduced below a pre-determined project-specific or sector-specific ceiling.Participation in a crediting mechanism is voluntaryand demand for generated certificates must thus becreated elsewhere. This can be done, for example, byallowing the certificates generated under the creditingmechanism to be traded in an emissions tradingscheme or under a carbon taxation programme. Use of certificates for voluntary offsetting of emissions can also provide an important source of demand.

The Clean Development Mechanism: Climate Change Mitigation as a Business Model

The first valuable experience to be gained with price-based climate action mechanisms at international levelcame in the form of the Clean Development Mecha-nism (CDM) – a crediting mechanism operated underthe Kyoto Protocol. Under the CDM, climate changemitigation projects and programmes can be registeredin developing countries according to internationalstandards, with the emission reductions achieved beingidentified and certified using internationally acceptedmethodologies. These certified emission reductions(CERs) can, for example, be used by companies coveredby the EU Emissions Trading Scheme (ETS) to meettheir emission reduction targets. The reductionsachieved thus help to reduce the costs involved inimplementing the emission reduction targets agreedunder the Kyoto Protocol.

The CDM has shown that price-based climate changemitigation mechanisms can be extremely productive.Since 2004, some 7,700 emission reduction projects andmore than 300 programmes have been registered, withsavings in the amount of 1.85 billion tonnes CO2eachieved. This represents about twice the amount ofgreenhouse gas emitted in Germany in 2015. If all pro-jects are implemented as planned and the anticipatedemission reductions are achieved as expected, the climate change mitigation contribution made by theCDM could eventually be ten times this amount.4

The CDM has not only helped industrialised countriesto meet their Kyoto Protocol commitments in an

affordable way, it has also aided the transfer of climatechange mitigation technology to developing countries.For example, CDM activities in the renewable energysector have resulted in the installation of facilities withoutput capacities of some 254 gigawatts (GW). Invest-ments in registered CDM projects amount to a com-bined value of a staggering 420 billion US dollars (as ofJuly 2017).

The CDM has also proven to be an extremely flexibleand adaptable mechanism. Over the years, CDM guide-lines and methodologies have been repeatedly adaptedand enhanced, not least to counter negative develop-ments. One particularly pioneering and thus positivedevelopment was the trend away from a purely project-based mechanism towards a more sectoral or program-matic approach. It is now possible to bundle a largenumber of smaller-scale projects into one Programmeof Activities (PoA) and to set what are known as Stan-dardized Baselines (SBs) to determine the emissionreductions achieved – not for individual projects butfor an entire industry sector. These approaches can sig-nificantly reduce the administrative effort involved inthe respective projects and secure the environmentalintegrity of the CDM.

The experience gained with the CDM is invaluable in further developing international climate actionmechanisms.

Environmentally compatible development: a CDM wind farm in the Philippines.

4 UNEP DTU, 2017. Using Market-based Mechanisms to Mitigate Climate Change 9

10 Using Market-based Mechanisms to Mitigate Climate Change

Carbon Pricing

The Paris Agreement: InternationalCooperation for Raised Ambition

At the climate change conference in Paris in December2015, a trailblazing international agreement wasreached. The Paris Agreement sets out the legal frame-work for all future global climate action from 2020 andbeyond. Thanks to the quick ratification by a largenumber of Parties, the Agreement went into effect onNovember 4, 2016. The following addresses key aspectsof the Agreement and explains how market-based cli-mate change mitigation mechanisms can be usedwithin the framework it provides.

Decarbonisation goes green The Paris Agreement sets out the goal of the interna-tional climate change regime as a legally binding tar-get: global warming is to be limited to well below twodegrees Celsius above pre-industrial levels and Partiesare to pursue efforts to limit the temperature increaseto 1.5 degrees Celsius above pre-industrial levels, recognizing that this would significantly reduce therisks and impacts of climate change. The Parties havealso committed to “achieve a balance between anthro-pogenic emissions by sources and removals by sinks ofgreenhouse gases in the second half of this century”.This rather awkward wording – which translates intogreenhouse gas neutrality – goes even further than thegoal of decarbonising the global economy, as called forby the G7 leaders at their meeting in Elmau in summer2015, because it takes in not just carbon but also othergreenhouse gases and specifically covers land use. Paristhus sends out a clear signal that the age of coal, oil andgas is coming to an end.

Nationally determined contributions But how do the Parties intend to achieve this long-term global goal? How can the challenge faced by theentire international community be transferred to indi-vidual states? Under the Paris Agreement, the Parties

have agreed that all countries must comply with theprovisions of international law and contribute to globalclimate change mitigation efforts: this means not justthe traditional industrialised countries, but also theemerging economies and developing countries. Allcountries are required to draw up national emissionreduction targets – called nationally determined con-tributions (NDCs) – which they must regularly submitto the UNFCCC. It was also agreed that each new NDCmust be more ambitious and exceed its predecessor.The actual targets and the associated levels of ambitionare, however, left to the countries to decide. The Partieshave a legal obligation to develop their NDCs andimplement measures in order to achieve them. Thisgives rise to a high level of political commitment forcountries to actually meet the targets they define.

Transparency mechanismThe binding nature of NDCs is to be achieved throughthe use of a global transparency mechanism, withcountries’ climate change mitigation efforts being subjected to binding international review. This trans-parency and monitoring mechanism also allows forcomparison of climate change mitigation activities,because for the first time ever, countries are now sub-jected to the same reporting rules. This review processposes a significant risk to Parties’ reputations if they failto deliver what they pledge in their NDCs. Also, a globalstocktake is conducted every five years to verifywhether the international community is on the rightpath to achieve the two degrees or 1.5 degree Celsiustarget. The first global stocktake will take place as earlyas 2018. Thus, by repeatedly shining the spotlight onthe climate change mitigation effort, the mechanismraises public awareness and can contribute significantlyto ensuring that steps are taken to actually implementNDCs.

Using Market-based Mechanisms to Mitigate Climate Change 11

12 Using Market-based Mechanisms to Mitigate Climate Change

Carbon Pricing

The need for raised ambitionIn the lead up to the climate change conference in Parismore than 180 countries developed intended nation-ally determined contributions. Of the 153 Parties thathave since ratified the Paris Agreement, 147 havedefined and announced binding emission reductiontargets (as of July 2017). However, analyses show thateven if they are fully met, these targets will not go farenough to enable a development pathway whichensures that the two degrees Celsius limit can besecured.

The question thus remains as to how ambition can beraised to the level needed. When implementing theircurrent NDCs, one option would be for countries toshow that climate change mitigation does not put aburden on economic development, but can providenew impetus for growth. If this is achieved, the coun-tries can exceed their NDCs and take a more ambitious

approach in future emission reduction effort. To ensurethis does not remain some pious wish, among others,cooperation mechanisms have been enshrined in Article 6 of the Paris Agreement to assist Parties’ ambi-tion-raising efforts. Such cooperation mechanismsform the legal framework to allow use of market-basedclimate change mitigation mechanisms under the Paris Agreement.

International cooperation mechanismsThe Paris Agreement contains a range of principleswhich apply when Parties intend to use cooperationmechanisms to achieve their NDCs:

■ Participation in the cooperation mechanisms isvoluntary and must be approved by the nationalgovernment.

COP23 2017

COP24 2018

COP25 2019

COP26 2020

COP27 2021

COP28 2022

COP29 2023

COP30 2024

COP31 2025

COP22 2016

COP21 2015

Paris Agreement adopted

Parties submit new or updated NDCs (period up to 2030)

Facilitative Dialogue Process Progress on the way to the 1.5/2°C target

Global stocktake Progress made in climate change mitigation, climate fnance and climate change adaptation

First Meeting of the Parties to the Paris Agreement

Parties submit new or updated NDCs

(period up tp 2035)

Adoption of the rule book of the Paris Agreement including for - future NDCs- global stocktake - cooperation mechanisms- transparency mechanism

Note: COP is the abbreviation used for the annual Conference of the Parties (COP) to the UN Framework Convention on Climate Change.Source: Wuppertal Institute

Figure 1: UNFCC negotiation schedule and milestones 2015 to 2030

Using Market-based Mechanisms to Mitigate Climate Change 13

■ Use of the cooperation mechanisms is designed toallow for raising climate action ambition, thusincreasing the effort in terms of climate changemitigation or adaptation.

■ The cooperation mechanisms are to promote sus-tainable development. While the main focus is onreducing greenhouse gas emissions, other sustain-ability aspects shall also be addressed.

■ The cooperation mechanisms shall ensure environ-mental integrity. This means that the mechanismsmay not be used to circumvent ambitious climatechange mitigation effort in the participating coun-tries, as this would lead to a hollowing out of theiremission reduction goals.

The Paris Agreement offers three approaches in the useof international cooperation mechanisms. First, Partiescan cooperate directly with one another (Article 6.2).

This makes it possible for emission reduction measuresto be implemented in one country and the resultingemission reductions to be transferred to another andcounted towards its NDC. It requires transparent processes and accurate accounting of the emissionreductions achieved to avoid emission reductions beingcounted more than once – for instance, in the emis-sions inventory of the country in which the reductionactivities are conducted and also in the country towhich the resulting emission reductions are trans-ferred. This would thus enable diverse forms of cooper-ation. Apart from direct trading of achieved emissionreductions between two governments, one countrycould also promote implementation of a climatechange policy in another and then count a portion ofthe emission reductions achieved towards its own NDC.In addition, national and regional instruments such asthe EU Emissions Trading Scheme can also be linked tosimilar schemes as one --> continued on page 16

14 Using Market-based Mechanisms to Mitigate Climate Change

Carbon Pricing

The Future of the Clean Development Mechanism

While the CDM serves as the basic framework for inte-grating the cooperative approaches into the ParisAgreement, its future remains uncertain in the face ofthe new climate change mitigation mechanisms beingintroduced.

The low demand for certificates under the CDM meansthat hardly any transactions are taking place. Given thecontinued low price for CERs, only few requests forcertificate issuance are being submitted and projectregistration is stagnating to boot. The new mecha-nisms, by way of contrast, can gain in importance evenbefore the Paris Agreement goes into effect: if, as seenwith the introduction of the CDM, a prompt start ruleis agreed to allow climate change mitigation activitiesto be retroactively registered under the new mecha-nisms, the agreed implementation rules could serve asa new standard whereby the CDM would continue tolose relevance.

This raises the question of whether and to what extentthe mechanism will be continued and further devel-oped, if at all. The CDM will be needed for some yearsto come, at least formally: at the climate change con-ference in Doha in 2012, a second commitment periodwas agreed for the Kyoto Protocol, the framework thatgoverns the CDM. That second period runs until 2020.Taking into account the ‘true-up period’ in which Par-ties are still able to conduct transactions to help themmeet their targets, the CDM is expected to remain rele-vant until 2023/2024.

Also, with the CDM, valuable experience has beengained and capacities created which could be of greathelp in the design and introduction of a new mecha-nism. At UN level, robust procedures and methodolo-gies have been introduced and institutions establishedto provide for effective quality monitoring and controlof climate change mitigation activities conductedunder the CDM. At the same time, all Parties haveimplemented processes at national level to allow themto benefit from using the CDM. In the private sector,considerable expertise has been developed, with audit-ing companies such as Germany’s Technical InspectionAssociation TÜV obtaining global experience in vali-dating emission reduction activities and building local

capacities. A range of consulting firms and projectdevelopers have also become specialised, both in iden-tifying climate change mitigation potential and indeveloping suitable methodologies to help leveragethat potential. One of the biggest challenges faced inthe coming years will be to find ways to use this CDM-related experience when structuring the cooperationmechanisms to be used under the Paris Agreement. Atthe same time, the question arises as to how climatechange mitigation activities initiated under the CDMcan be continued in times of poor CER demand.

The Nitric Acid Climate Action Group (NACAG)launched by the Federal Government at the climatechange conference in Paris addresses this very issue.NACAG plans to halt global nitric acid emissions innitrous oxide production. Nitric acid is a compound ofhydrogen, nitrogen and oxygen which is used in theproduction of fertilisers. In the past, the CDM has beenused to reduce large quantities of the emissions whichoccur in fertiliser production. However, due to the fallin prices for certificates, there is a risk that availablereduction technology can no longer be used and thatthis extremely cheap reduction potential can no longerbe tapped. To drive sectoral transformation nonethe-less, NACAG offers guidance and information and alsoprovides financial support for those countries willingto address the sector and take mitigation into theirown hands from 2020. This will enable efficient reduc-tion of emissions of nitric acid (N2O), which is anextremely potent greenhouse gas, despite the fall inprices on the global carbon market.

Further information: www.nitricacidaction.org

The German government additionally supports theWorld Bank’s Pilot Auction Facility for Methane andClimate Change Mitigation (PAF). The PAF also targetsCDM projects which are at risk of being halted becauseof the drop in certificate prices. In doing so, it uses theparticularly innovative approach of buying CERs frommethane projects at guaranteed prices by offering putoptions at competitive auctions. The put options aresecured by funding provided by the countries involved:in addition to Germany, these are Switzerland, Swedenand the US. Having obtained a put, the successful

Using Market-based Mechanisms to Mitigate Climate Change 15

bidder then has the right to sell certificates to the PAFat the price set by the auction. By auctioning the puts, it is possible to determine the amount of funding projectdevelopers need to continue their climate change mitigation activities, guaranteeing maximum climatebenefit as a result. This was the process used in a thirdauction in January 2017. With puts worth 13 million USdollars, reductions amounting to some 6.2 milliontonnes of CO2e can be achieved. While the first two

auctions held in 2015 and 2016 addressed methaneemissions from landfills, the third auction focused onreducing emissions of nitric acid (N2O) which, likemethane, is an extremely potent greenhouse gas.

Further information: www.pilotauctionfacility.org

Use of nitrogen fertiliser in farming is vital in ensuring soil fertility and supply of nutrients for crops. In the production of nitric acid, a key component of nitrogen fertiliser, emissions of nitrous oxide (N2O) occur.

16 Using Market-based Mechanisms to Mitigate Climate Change

Carbon Pricing

of the cooperative approaches provided for under Arti-cle 6.2. Whether all of these cooperation forms willactually be possible and under what conditions is cur-rently the subject of negotiations between Parties to theUN Framework Convention on Climate Change. Guide-lines on using these cooperative approaches will bedecided in 2018.

A second option involves the use of the newly createdmechanism to contribute to the mitigation of green-house gases and support sustainable development(Article 6.4). This mechanism will be supervised by abody designated by the Conference of the Parties. Inaddition, the Conference of the Parties will adopt rules,modalities and procedures which must be observedwhen implementing activities under Article 6.4. Theaim is to ensure that standardised procedures are fol-lowed in the design and implementation of emissionreduction activities and when verifying the resultsachieved.

Another unique aspect of the mechanism is its goal ofmobilising the private sector to participate in climatechange mitigation by providing suitable incentives.The Paris Agreement will thus offer private-sectoractors an opportunity to directly use the mechanismestablished under Article 6.4.

As with the bilateral cooperation approaches providedfor under Article 6.2, the emission reductions achievedusing this mechanism can be transferred from thecountry in which they were generated to anothercountry and counted towards its NDC. These transfersmust also result in raised ambition. And under Article6.4 of the Paris Agreement, use of the mechanism mustalso lead – as a net global outcome – to an absolutereduction in global greenhouse gas emissions.

As a third option, use of non-market-based approachesis provided for under Article 6.8. As the name suggests,market-based climate change mechanisms play no roleat all. Just how these non-market-based approaches areto work will be determined in the coming years withthe development of a “framework for non-market-based approaches”.

Challenges arising from use of cooperation mechanisms under theParis Agreement While the Paris Agreement is a done deal and has beenin effect for the past year, many questions still need tobe answered before the measures it contains can actu-ally be implemented. Many of the details contained inthe Agreement’s small print have still to be finalised,including those concerning the cooperation mecha-nisms. This is the case, for example, concerning howuse of the cooperation mechanisms can be kept separate from NDCs. What portion of its emissionreductions can be defined as a host country’s nationalcontribution and what portion can be transferred toanother country? How will use of the mechanisms in a given NDC period affect the targets defined for thesubsequent period several years on? The cooperationmechanisms must thus be designed in a way that theyprovide no incentive whatsoever for host countries todelay their own climate change mitigation activitiesbecause, rather than taking efforts to reduce their own emissions, they would prefer to sell their CERs.

Also, the industrialised countries have committed tosupporting developing countries’ climate action effortsby providing both finance and technology. If emissionreductions are transferred between countries it usuallymeans that money is involved. How can this flow offunding be separated from the climate financeamounts agreed? Clear rules are needed here.

To ensure that emission reductions can be docu-mented in a transparent way, a robust transparencyand accounting system is needed which allows the flowof finance, the emission reductions achieved and theassociated reduction measures to be clearly recordedand traced. This kind of system still has to be devel-oped for the Paris Agreement as a whole, posing one ofthe biggest challenges the international climate changeregime will face in the near future.

Not all countries have set out their NDCs as absoluteemissions ceilings over a period of several years. Somehave set themselves the goal of reducing the carbonintensity of their economies, meaning the greenhousegases emitted for each dollar or euro generated. Others,by way of contrast, have chosen not to reduce emis-sions in absolute terms, but in relation to a hypotheti-cal business-as-usual scenario. And there are even

Using Market-based Mechanisms to Mitigate Climate Change 17

Market Mechanisms and Nationally Determined Contributions

Many countries state that they intend to use market-based mechanisms in their NDCs. However, only a fewsay that they intend to purchase international creditsand count these towards those NDCs. By way of con-trast, a large number of countries say they want to

finance their climate action by selling internationalcredits. However, the number of countries wanting toimport international credits may grow as the level ofambition in nationally determined contributions israised.

International Market Mechanisms, Sellers

National Market Mechanisms

Use of Market Mechanisms not Intended

International Market Mechanisms, Buyers

Market Mechanisms being Considered

No NDC submitted

Source: Wuppertal Institute

Figure 2: Overview of the use of market-based climate change mitigation instruments in nationallydetermined contributions (NDCs)

18 Using Market-based Mechanisms to Mitigate Climate Change

Carbon Pricing

countries which, when defining their NDCs, do notonly consider greenhouse gas emissions as an indicatorbut also factors such as increased renewable energy use and improved energy efficiency. This wide range of very different types of commitment poses a hugechallenge when it comes to defining common rules and requirements to govern the international transferof CERs.

Great inroads already madeFrom a German perspective, the negotiations on thenew market mechanisms have been a success despitethe many open issues that remain. Several importantenhancements have been achieved in relation to themarket-based mechanisms operated to date. While upto now, a purely project-based approach has been usedunder the CDM, the cooperation mechanisms con-tained in the Paris Agreement take a different, moreopen approach. They are designed to allow considera-tion of entire sectors, develop large-scale programmesand co-finance implementation of targeted policiessuch as renewable energy feed-in tariffs (based on Ger-many’s Renewable Energy Sources Act [the EEG]). Thiscould give the mechanisms a new and considerablywider reach.

Using Market-based Mechanisms to Mitigate Climate Change 19

Another significant success is that the Paris Agreementbrings raised ambition firmly to the forefront. The pro-visions of Article 6 require that host countries makeown contributions and that use of the new mechanismcreated under Article 6.4 must result in an overallreduction in global emissions of greenhouse gas.

Last but not least, it is important that the mechanismsdo not focus solely on reducing emissions of green-house gas. They must also promote other sustainabilityaspects in a targeted way.

With regard to implementation of the necessary frame-work, the negotiations held in Marrakech at the end of2016, and also the interim talks held in Bonn last May,have driven the process a good way forward. Althoughthere remain some differences of opinion, there are

signs that a mutual understanding will be reached as tohow the mechanisms under Article 6 can be integratedinto the Paris Agreement structure and contribute toachieving its goals. The task now at hand is to furtherstrengthen this mutual understanding to ensure thatthe Paris rule book to be adopted at the end of 2018 is both precise and action-oriented to the greatest possible extent.

20 Using Market-based Mechanisms to Mitigate Climate Change

Carbon Pricing

Price-based Climate Change MitigationEfforts Worldwide

Using Market-based Mechanisms to Mitigate Climate Change 21

While the negotiations on international use of market-based mechanisms have been stepped up following theadoption of the Paris Agreement, efforts to establishprice-based mitigation instruments continue apace.Even in the run up to the Paris climate conference,when the global carbon market was laden with uncer-tainty, an increasing number of countries and regionsplanned to introduce their own emissions tradingschemes or already had them in place. It seems thatcarbon pricing is also increasingly being seen as anattractive climate change mitigation tool outside theframework of the international regime.

In 2016, China introduced emissions trading schemesin eight important industry centres. These are designedas pilots to pave the way for the introduction of anational emissions trading scheme some time towardsthe end of 2017. The planned national scheme will bethe biggest emissions trading scheme in the world andwill regulate more than twice the emission quantitiescovered by the EU ETS.

South Korea has been operating what is the second-largest emissions trading scheme after the EU ETSsince the start of 2015. Switzerland and New Zealandhave also introduced national systems. A nationalscheme introduced in Kazakhstan has since been puton hold. During a two-year review phase, the scheme’sprocedures are to be optimised and its design adaptedto the country’s changing economic situation. Kaza-khstan plans to reintroduce the scheme in 2018.

Apart from these national approaches, some countrieshave also introduced emissions trading at sub-nationallevel. There are currently two emissions tradingschemes in place in the US: the Regional GreenhouseGas Initiative in the north-west, and the emissionstrading scheme in California.

In Canada, which recently adopted a framework atnational level requiring all jurisdictions to introducecarbon pricing instruments by 2018, Ontario is launch-ing an emissions trading scheme and is the secondprovince to do so after Québec. Many others are set tofollow, among them Manitoba and Nova Scotia.

In Japan, sub-national emissions trading schemes havealso been introduced in the metropolitan regions ofTokyo and Saitama. Similar schemes are either underdiscussion or being developed in many other countriesand regions.

Carbon taxation schemes are also starting to take holdand are already in place in several EU member states aswell as in Switzerland, Mexico and Japan. While Chilehas been levying a carbon tax since January this year,South Africa has postponed its own carbon taxationplans yet again. Most recently, Columbia introduced atax on burning liquid and gaseous fossil fuels.

In addition to emissions trading schemes and carbontaxation, other carbon pricing instruments have beenintroduced over the past two years. As a supplement toits existing carbon tax, the Canadian province of BritishColumbia launched a baseline and credit scheme in2016. And earlier this year, Washington State in the USintroduced a similar scheme covering two-thirds of itsemissions. To achieve their emission reduction targets,the facilities covered by these schemes can conduct cli-mate change mitigation activities or trade their emis-sion reductions with others in their respective scheme.In Australia, the Safeguard Mechanism operated sinceJuly 2016 works somewhat differently: in this baseline-and-offset approach, baselines are defined for the com-panies participating in the scheme. If the baselines areexceeded, participants can buy offsets to meet theirreduction targets. In contrast to baseline-and-creditschemes, emitters in the baseline-and-offset schemes

22 Using Market-based Mechanisms to Mitigate Climate Change

Carbon Pricing

ETS implemented or scheduled for implementation

Carbon tax implemented or scheduled for implementation

ETS or carbon tax under consideration

ETS and carbon tax implemented or scheduled

ETS implemented or scheduled, tax under consideration

Carbon tax implemented or scheduled, ETS under consi

The circles represent subnational jurisdictions: subnational regions are shown in large circles and cities are shown in

circles. The circles are not representative of the size of the carbon pricing initiative.

Note: Carbon pricing initiatives are considered “scheduled for implementation” once they have been formally adoptedthrough legislation and have an official, planned start date. Carbon pricing initiatives are considered “under considerathe government has announced its intention to work towards the implementation of a carbon pricing initiative and thbeen formally confirmed by official government sources. Jurisdictions that only mention carbon pricing in their INDCnot included as different interpretations of the INDC text are possible. The carbon pricing initiatives have been classifiETSs and carbon taxes according to how they operate technically. ETS does not only refer to cap-and-trade systems, bbaseline-and-credit systems such as in British Columbia and baseline-and-offset systems such as in Australia. Carbonhas evolved over the years and initiatives do not necessarily follow the two categories in a strict sense. The authors re

that other classifications are possible.

Tally of carbon pricing initiatives

National Level Subnational Level

22

14

440

24

2

22

NEW ZEALAND

BRITISH COLUMBIA

WASHINGTONOREGON

CALIFORNIA

MEXICO

CHILE

BRAZIL

RIO DE JANEIROSÃO PAULO

RGGI

ALBERTA MANITOBA

ONTARIO

NEWFOUND- LAND AND LABRADOR

QUÉBECICELAND

EU

TURKEY

UKRAINEKAZAKHSTAN

CHINA

THAILAND

JAPAN

SOUTH AFRICA

REPUBLIC OF KOREA

PORTUGAL

IRELAND

SWEDEN

FRANCESWITZERLAND

SLOVENIA

ESTONIA

FINLAND

LATVIA

POLAND

NORWAY

DENMARK

KYOTOBEIJING

TIANJIN

HUBEISHANGHAI

CHONG- QING

SHENZHEN

TAIWAN

GUANGDONG

TOKIOSAITAMA

REPUBLIC OF KOREA

CANADA

AUSTRALIA

COLOMBIA

UK

ETS implemented or scheduled for implementation

Carbon tax implemented or scheduled for implementation

ETS or carbon tax under consideration

ETS and carbon tax implemented or scheduled

ETS implemented or scheduled, tax under consideration

Carbon tax implemented or scheduled, ETS under consideration

Source: World Bank, Ecofys and Vivid Economics 2016.

Figure 3: Overview of the various price-based climate change mitigation mechanisms currently beingplanned or which are already in place.

Using Market-based Mechanisms to Mitigate Climate Change 23

Little practical experience has been gained with thisoption, however, because the requirements for its usehave yet to be finalised. In Columbia, the recently intro-duced tax on burning fossil fuels will possibly alsoallow for the use of offsets because companies that can provide proof of their carbon neutrality are exemptfrom the tax. South Africa is also considering using an offsetting option when it introduces its own carbontax. Chile is also looking to add an offsetting option toits existing carbon tax.

An ever greater share of global greenhouse gas emis-sions has thus been covered by carbon pricing in recentyears. A World Bank study conducted in 2016 predictsthat around 13 percent of the global greenhouse gasemissions emitted in 2017 will be covered by a carbontax programme or an emissions trading scheme.5

This positive trend is, however, countered by the factthat in many countries, exorbitant climate-damagingsubsidies are still being paid. Although these subsidiesare on the decline, dropping from almost 500 billion US dollars in 2014 to 225 billion US dollars in 2015, thisdownward trend is not entirely the result of policyreforms. It is also being driven by low market prices forfossil fuels.6 International policy initiatives to with-draw subsidies altogether thus remain crucial. With-drawal of subsidies makes both economic and climatepolicy sense, but it will nonetheless be difficult toimplement in policy terms due to the distributioneffects involved. However, if global warming is to belimited to well below two degrees Celsius, it remainsvital that subsidies on fossil fuels be withdrawn.

do not automatically receive credits if their emissionsfall below their respective baselines.

One relatively new development is the introduction ofgreenhouse gas taxation (also known as carbon tax),which has been expanded to include an offsetting com-ponent. This offsetting option allows companies sub-ject to greenhouse gas taxation to pay a portion of thattax by submitting emission reduction certificates gen-erated from mitigation activities. By investing early inemission reduction activities, companies can thus gainan economic advantage rather than simply paying thetax. From a climate policy standpoint, this hybridmodel has the advantage that investment in an emis-sion reduction activity secures a climate protectioneffect. By way of contrast, with the simple levying of acarbon tax, use of that revenue for climate change miti-gation is not necessarily guaranteed. Mexico is one ofthe pioneers in applying this hybrid approach, havingintroduced a tax on fossil fuels in 2014 which allowsthe companies involved to submit certificates fromMexican CDM activities to reduce their tax burden.

5 World Bank, Ecofys and Vivid Economics (2016): State and Trendsof Carbon Pricing 2016.

6 International Energy Agency (2016): World Energy Outlook 2016.

The circles represent subnational jurisdictions: sub-national regions are shown in large circles and citiesare shown in small circles. The circles are not repre-sentative of the size of the carbon pricing initiative.

Note: Carbon pricing initiatives are considered“scheduled for implementation” once they havebeen formally adopted through legislation and havean official, planned start date. Carbon pricing initia-tives are considered “under consideration” if thegovernment has announced its intention to worktowards the implementation of a carbon pricing ini-tiative and this has been formally confirmed by offi-cial government sources. Jurisdictions that onlymention carbon pricing in their INDCs are notincluded as different interpretations of the INDCtext are possible. The carbon pricing initiatives havebeen classified in ETSs and carbon taxes according tohow they operate technically. ETS does not onlyrefer to cap-and-trade systems, but also baseline-and-credit systems such as in British Columbia andbaseline-and-offset systems such as in Australia.Carbon pricing has evolved over the years and initia-tives do not necessarily follow the two categories ina strict sense.

24 Using Market-based Mechanisms to Mitigate Climate Change

Carbon Pricing

German Government Supports the Development of Innovative Climate Change Mitigation Tools

For developing countries, international support in theimplementation of innovative climate change mitigationtools is of key importance. However, they still have hardlyany experience in introducing market-based mecha-nisms at local level. International exchange and transferof experience gained in other regions can be of greatvalue, as can providing advice to local actors on site. This is why, in addition to targeted bilateral cooperationactivities, the German government supports a range ofinternational initiatives that contribute significantly inthis field.

The Partnership for Market Readiness (PMR) launchedin 2010 is designed to support developing countries inpreparing for and implementing innovative climatechange mitigation tools. It uses a two-phased approach:in the first phase, the participating countries (with PMRassistance) prepare market readiness proposals (MRPs)setting out specific measures for targeted preparationand implementation of price-based climate change miti-gation instruments. In the second phase, those countrieswhose MRPs have been approved receive technical andfinancial support in developing and implementing themeasures they have planned.

In addition to these specific support measures, the PMRalso promotes bilateral exchange of information betweencountries that already use such instruments and those

still considering whether to introduce them. The PMRtakes a strong participative approach which allows itsplayers to exchange technical experience independent ofany political controversy. The experience gained can alsoprovide valuable input to assist the official UN process.

At the climate change conference in Paris, Norway, Ger-many, Sweden and Switzerland announced that they hadjoined the World Bank in launching the TransformativeCarbon Asset Facility (TCAF) – another initiative to pro-mote new forms of market-based emission reductionactivity. Using public funds to the tune of 500 US dollars,private industry is to be mobilised to generate climateinvestment worth over two billion US dollars. The TCAFwill fund emission reduction activities using broad-basedprogrammes to overcome the project-based approach,achieving a transformative effect in partner countries.The funded measures are integrated into the respectivenational climate change strategies, thus boostingnational climate change mitigation effort and securing alasting contribution to achieving climatically sound sustainable development. TCAF activities will be closelylinked to the process under the international climatechange regime: transformative experience is to be transferred to other regions and will also contribute toimplementation of the Paris Agreement.

Climate change and global aviation

Although all Parties to the Paris Agreement haveagreed to operate ambitious climate change policies,emissions from international aviation – which are notcovered by the Agreement – continue to rise. The Inter-national Civil Aviation Authority (ICAO) has set itselfthe goal of stabilising net emissions from the aviationsector from 2020 onwards. To enable carbon-neutralgrowth in the aviation sector as of 2020, a range ofmeasures will be used: increased efficiency in groundoperations, optimised flight routes, use of biofuels andimproved efficiency in global aircraft fleets. However,

given the growth seen in the aviation sector, thesemeasures will be nowhere near enough to harness itsfuture emissions.

Thus, in autumn 2016, the ICAO General Assemblydecided to adopt a global market-based mechanism –the Carbon Offsetting and Reduction Scheme for Inter-national Aviation (CORSIA). The mechanism will beused to offset emissions from aviation with certifiedclimate change mitigation projects on the ground.CORSIA’s phased introduction involves voluntary participation from 2021, with all countries – except the poorest developing countries – being required to

Using Market-based Mechanisms to Mitigate Climate Change 25

participate from 2027. Some 70 countries, includingGermany, have already declared their willingness toparticipate in CORSIA voluntarily. This means thatmore than 80 percent of international aviation will becovered by the CORSIA scheme.

If CORSIA is to become an effective climate changemitigation tool then, among other things, robust ruleson monitoring, reporting and verification of emissionswill need to be established, as will clear and concisequality control criteria for the certificates that airlineswill be allowed to use to offset their increased emis-sions. Also, reliable accounting of transferred emission

reductions is key. It must thus be ensured that theCORSIA mechanism is subject to the same require-ments as the cooperation mechanisms contained in theParis Agreement. Environmental integrity can only beguaranteed if the certified emission reductions are documented accurately and verifiably in the climateinventories of the countries in which they are achievedand are not counted towards other emission reductiontargets at the same time. These and other aspects of therelationship between the ICAO and the UNFCCC mustbe taken into account when developing CORSIA rulesand procedures. These are to be developed in thecourse of 2017.

26 Using Market-based Mechanisms to Mitigate Climate Change

Carbon Pricing

Policy Coordination for Fragmented Carbon Markets

Largely independent of developments at UN level, arange of market-based mechanisms have been devel-oped at national and sub-national level in variousregions in recent years. This expansion reflects theattractiveness of market-based mechanisms and presents an important opportunity for climate changemitigation worldwide. The diversity in the mecha-nisms’ design could, however, prove difficult for subse-quent linking of the various schemes. Important cli-mate change potential would thus go unused, as wouldthe opportunity to improve efficiency and secure theenvironmental integrity of the activities involved.

There is thus an urgent need to coordinate these poli-cies through international cooperation. This is theapproach taken by the Carbon Market Platformformed under Germany’s G7 presidency in June 2015.As a platform for dialogue, it serves strategic exchangeon the further development of the global carbon market.

Open dialogue on market-based mechanisms fosters a better understanding of the differing national andregional approaches involved. It also encouragesexchange on related drivers, obstacles and experience

Under the Carbon Pricing Leadership Coalition, price-based climate mitigation instruments are discussed at the highest political level.Christine Lagarde, Managing Director of the International Monetary Fund, in talks with top government officials.

Using Market-based Mechanisms to Mitigate Climate Change 27

gained. How and to what extent should the differentapproaches be coordinated? Which of the approachesadopted bring the greatest benefits? By providinganswers to questions like these, the Carbon MarketPlatform will help to boost environmental integrity,improve efficiency and eliminate competitive mind-sets. Through open dialogue, the platform will also sup-port and enhance negotiations held under the auspicesof the UNFCCC. The platform thus offers a new oppor-tunity for international cooperation and serves to stimulate policy-based ideas for further developmentof the global carbon market.

In addition to high-ranking decision makers in the G7and the European Commission, the Carbon MarketPlatform is also open to representatives from variousinternational organisations like the World Bank, theInternational Carbon Action Partnership (ICAP), theUNFCCC and the Organisation for Economic Coopera-tion and Development (OECD). At a high-profile meet-ing in June 2016, participants from the G7 countriesand also from Chile, Indonesia, New Zealand, Senegal,Switzerland and Vietnam exchanged views and experi-ence on using international carbon markets and devel-oping national carbon pricing instruments. A secondCarbon Market Platform meeting was held in Rome inSeptember 2017. A high point of this strategic dialogueinvolved exchange on the issue of how market-basedinstruments should be designed in order to raise ambition in climate change mitigation effort. Duringthe dialogue, ways were identified in which the CarbonMarket Platform can contribute to this process.

Various levels of international cooperation – fromcoordinating standards and price corridors to linking –were also discussed.

By promoting this kind of exchange between interestedcountries, the Carbon Market Platform serves in driving new forms of cooperation and in developing common carbon market strategies.

Germany is also a member of the Carbon Pricing Lead-ership Coalition (CPLC), which has set itself the goal ofadvancing the carbon pricing agenda worldwide. TheCoalition, which was called into being by the WorldBank, was announced during the climate change con-ference in Paris in November 2015. It brings togetherleaders from national and sub-national governments,the private sector and civil society to support theimplementation of existing carbon pricing policies anddrive the introduction of new policy measures. TheCPLC is to develop guidelines for effective carbon pric-ing. Experience gained in designing and implementingcarbon pricing policies will be collated by the CPLC.The work performed by the Coalition will be supportedby parallel policy-making and research. Political sup-port will be provided by the Carbon Pricing Panel com-prising the heads of seven national and sub-nationalgovernments along with high-ranking representativesfrom the World Bank, the IMF and the OECD. With theaim of further improving the scientific basis on whichto introduce carbon pricing, the CPLC is also forming a High-Level Commission on Carbon Pricing. TheCommission will work to identify development pathways for rapid decarbonisation which also enableimplementation of the UN Sustainable Development Goals (SDGs).

28 Using Market-based Mechanisms to Mitigate Climate Change

Carbon Pricing

The voluntary marketIn addition to the compliance market, meaning themarket whose demand is fed by the binding emissionreduction targets of the industrialised countries, a mar-ket for voluntary offsetting of greenhouse gas emis-sions has also developed in recent years. This newermarket enables businesses and individuals to reducetheir carbon footprint voluntarily. For example, Ger-man provider atmosfair makes it possible for privatecustomers to offset their air miles from private traveland business trips.

Buyers need not necessarily use certificates that meetthe strict international rules laid down by the UNFCCC.A number of private initiatives have responded bydeveloping their own certification mechanisms. Pio-neers in this field include the Verified Carbon Standard(VCS) and the Gold Standard Foundation. These stan-dards each have their own requirements regarding thedesign and implementation of emission reduction

activities. Some focus purely on the climate impact ofthe certified projects, while others take a broaderapproach which includes their social and environmen-tal impacts. Combinations of different standards arealso possible and are frequently used. Certificates generated by projects with especially high social andenvironmental additionality are particularly attractiveto voluntary market buyers.

Since the voluntary carbon market came into opera-tion, approximately one billion tonnes of CO2e havebeen transferred, with total investment worth close to4.8 billion US dollars. In 2016, voluntary demand forcertificates dropped to 63 megatons of CO2e, represent-ing a decline of 24 percent compared with the previousyear.7 Most certificates are bought by companies and inmany cases, their engagement is driven by the desire to

7 Ecosystem Marketplace (2017): Unlocking Potential–State of theVoluntary Carbon Markets 2017

Using Market-based Mechanisms to Mitigate Climate Change 29

accept their corporate social responsibility (CSR) andposition themselves as an environmentally consciousenterprise. German companies like Puma, DeutschePost DHL Group and Allianz all use voluntary offset-ting. The German government also voluntarily usescarbon certificates to offset the air miles accrued inbusiness trips conducted by members of the govern-ment and ministry employees. In doing so, the govern-ment uses certificates generated under the CDM.

Use of the voluntary market has enabled private businesses to gain experience with market-basedmechanisms which could well give them a competitiveadvantage should binding schemes be introduced at a later date. But in addition to private businesses,national governments also benefit indirectly from thevoluntary market. In the US state of California and inAustralia, experience gained with voluntary offsettinghas been used in designing emission reductionschemes which are partly based on the methodologiesused in the voluntary market. Because up to now, the

CERs traded on the voluntary market have not beenused to meet binding emission reduction targets, it hasbeen possible to experiment with a range of differentapproaches without putting the environmentalintegrity of the global Kyoto system at risk. In someareas, the voluntary market has thus been able to function as a groundbreaker for later binding schemes.

With the Paris Agreement’s entry into force in Novem-ber 2016, the voluntary market is equally subject toaltered conditions. Under the Agreement, all countriesare required to contribute to the global climate changemitigation effort. In terms of the voluntary market, thisraises the question as to how emission reductions canbe accurately documented and accounted for in hostcountries’ greenhouse gas inventories. Key players inthe voluntary market, among them the Gold StandardFoundation, are currently working on proposals settingout how the voluntary market can fit into this alteredenvironment.

30 Using Market-based Mechanisms to Mitigate Climate Change

Carbon Pricing

The Future of the Global Carbon Market: Open Issues on the Road toImplementation

The Paris Agreement is a milestone in international cli-mate change policy. It sets out a new legal frameworkfor climate change mitigation at global level, with mar-ket-based mechanisms playing a key role. Article 6 ofthe Agreement enables the Parties to use cooperationmechanisms. These in turn allow emission reductionsto be transferred between countries. This means thatemission reduction activities can be implemented inone country, but a portion of the resulting emissionreductions can be counted towards the emission reduc-tion target of another. The Paris Agreement thus laysthe foundation for the use of market-based climatechange mitigation mechanisms beyond national bor-ders. Many issues of central importance in their imple-mentation remain open, however. These must beaddressed and clarified in the course of the comingyears.

The Agreement’s cooperation mechanisms must bedesigned in such a way that emission reductions can beaccurately recorded and counted towards the nationalgreenhouse gas inventories of the countries involved.This is the only way to prevent double counting of theemission reductions achieved, first by the host countryand then again by the country to which the reductionsare transferred.

Also, clarification is necessary regarding the relation-ship between finance provided in relation to the coop-eration mechanisms and general climate finance. It isalso necessary to prevent double counting – in this caseof the funding provided – because the cooperationmechanisms were created explicitly to raise climatechange ambition and not to provide an escape hole forcountries wanting to duck out of serious climatechange mitigation effort.

Finally, the issue of how, in relation to a country’s exist-ing emission reduction target, use of the cooperationmechanisms will impact the design and ambition of itsfuture NDCs. The implementation requirements for thecooperation mechanisms and the associated guidelinesmust ensure that the mechanisms provide no incentivewhatsoever for host countries to minimise their owncontributions to mitigating climate change and pushclimate change mitigation ambition off onto othersbecause they prefer to sell their emission reductionpotential on the carbon market.

One central challenge in all of this will involve devel-oping the climate change mechanisms at differing lev-els without approaching each of them in isolation.More and more price-based mechanisms are beingplanned, developed and introduced – both at nationaland at sub-national level. The global framework set outby the Paris Agreement must thus be designed in a waythat does not detract from these initiatives, but rathersupports and harmonises them while securing theenvironmental integrity of the system as a whole.

The German government is thus committed to findinga solution to all of the challenges outlined above, theultimate aim being to ensure that the internationalcooperation mechanisms contained in the Paris Agreement will secure the environmental integrity of the climate change regime, contribute to greaterreduction of emissions and drive sustainable development in countries that implement action to mitigate climate change.

Using Market-based Mechanisms to Mitigate Climate Change 31

www.bmub.bund.de/english