Please advise on the likely status of:

• emissions trading credits relating to Article 17 of the Kyoto Protocol (emissions trading); and
• emission reduction units relating to Article 6 of the Kyoto Protocol (joint implementation)

under the Paris Agreement due to be agreed at the end of this year and which is intended to come into force in 2020 following the end of the second Kyoto commitment period (Paris Agreement). We have also included units issued under the Clean Development Mechanism (CDM) under Article 12 in our advice.

Advice:

1. Kyoto Protocol

1.1 Mechanisms under the Kyoto Protocol

Under the Kyoto Protocol, countries with emissions reduction commitments (Annex B countries) are assigned ‘Assigned Amount Units’ (AAUs) equivalent to the number of tonnes of carbon dioxide equivalents they are allowed to emit during the relevant Kyoto commitment period.  If they emit more than their allocation of AAUs, they have to buy AAUs and if they emit less they can sell the excess AAUs assigned to them.  Article 17 of the Kyoto Protocol permits countries to trade AAUs, as well as certified emission reductions (CERs), which are units issued under the Clean Development Mechanism (Article 12) relating to projects undertaken in developing countries and Emission Reduction Units (ERUs) issued under the joint implementation scheme (Article 6) in relation to projects undertaken in developed countries, in order to meet their commitments.

1.2 Carry-over to Second Kyoto Commitment Period

The issue of the treatment of surplus AAUs, ERUs and CERs was considered by parties to the Kyoto Protocol on entering the second Kyoto commitment period (2012 – 2020).  The decision was made to allow countries to carry over any unused AAUs into the second commitment period.  CERs and ERUs may also be carried over, but limited to up to 2.5% of the Party’s original allocation of AAUs for the first commitment period.  Such carry-over transactions, as initiated by national registries, result in the serial numbers of the ERUs and CERs being updated.  Each Party may determine which ERUs and CERs in its national registry are to be carried over. ERUs that have been converted from removal units resulting from last use, land use change and forestry related activities (RMUs) may not be carried over.

2. Paris Agreement

2.1 Paris conference

The intention is that there will be no third commitment period for the Kyoto Protocol, but instead a new agreement will be entered into between the Kyoto parties in 2015, to apply from 2020 onwards.  The Paris conference is due to take place from 30 November to 11 December 2015 and the aim of this conference is to agree a form of agreement governing greenhouse gas emission reductions with the ultimate aim of limiting global temperature rise to below 2 degrees Celsius.

2.2 Negotiating Text

A negotiating text has been published, but no firm decisions have been made at this point on the content of the Paris Agreement.  It is therefore not possible to say with any kind of certainty what status surplus AAUs or any international equivalent carbon credits, ERUs or CERs from the second commitment period will have under the Paris Agreement:  negotiations between the parties have not proceeded far enough at this stage to answer this question.

2.3 INDCs

The intention was that countries that have signed up to the Kyoto Protocol were to have submitted ‘intended nationally determined contributions’ (INDCs) relating to the Paris Agreement by 31 March 2015.  These are the pledges or mitigation commitments made to the UN by Kyoto countries on how far they intend to reduce their greenhouse gas emissions.

Not all countries have submitted an INDC yet, but it is useful to look at the INDCs of those that have to get some perspective on whether international market mechanisms are generally intended to play a part in meeting their mitigation commitments.

The EU and the USA have submitted their INDCs and both have stated that there will be no contribution of international market-based mechanisms to meet their stated targets.

New Zealand, on the other hand has stated that its emission reduction aim is conditional upon confirmation of accounting rules in Paris that will allow it unrestricted access to global carbon markets.  Japan intends to use its own crediting mechanism to reduce its domestic target further.  China has stated interest in promoting a carbon emission trading market and aims to build domestic carbon emission trading pilots.

Members of the European Parliament have backed plans to suspend surplus credits from the EU ETS market (which shadows Kyoto AAUs) and boost prices but this is yet to be agreed by member states.  It is argued that failure to remove surplus credits from the EU ETS could weaken the targets if unused, banked credits are counted towards future emissions reductions.

It seems, therefore, that there is divided thinking on the use of market mechanisms generally, and there will be some strong proponents of cancelling surplus units or at least limiting their use post-2020.

3.  What status will existing units and credits have post-2020?

Using the negotiating text of the Paris Agreement prepared by the Ad Hoc Working Group on the Durban Platform for Enhanced Action (Bonn Germany June 2015) along with the INDCs submitted to-date, we set out below the main options that will be available in relation to carrying over AAUs, CERs and ERUs.

From our analysis of the references to markets, economic mechanisms and internationally transferable mitigation outcomes resulting in units, it seems that the following options are under consideration at this stage:

(a) Market-based mechanisms retained but current schemes wound up

Market-based mechanisms may be retained under the Paris Agreement, but these could potentially be entirely new mechanisms, with the CDM and JI being wound up.  Credits from these existing mechanisms may therefore not be transferable.  Surplus units would then be cancelled in 2020.

(b) Market-based mechanisms retained which interact with current schemes

Current market-based mechanisms could be retained, including the Joint Implementation Mechanism and Clean Development Mechanism.  Potentially ERUs, CERs and AAUs could be carried over or converted from the Kyoto second commitment period to the new regime.  Mention is made in the Negotiating text of parties claiming towards their commitment mitigation, outcomes achieved in other parties, subject to specific rules to ensure integrity is maintained.  Therefore including a mechanism along the lines of the CDM or JI is a possibility.  It is likely that, if CERs and ERUs held from the Kyoto second commitment period are able to be transferred or converted into units that are recognised under the new regime, a limit or restriction will be placed on this, in a similar way to the restrictions placed on carrying over units from the first to the second Kyoto commitment period (please see section 1.2 above).

There is mention in the Negotiating Text of UNFCCC-approved mechanisms and mechanisms outside the UNFCCC.  Units from UNFCC-approved mechanisms may be transferable and able to be used to meet contributions/commitments/action of parties under the Paris Agreement.    Mitigation units emanating from mechanisms outside the UNFCCC may be used to meet contributions provided they meet conformity requirements. The impact of this on CERs and ERUs would therefore depend on whether these schemes continue to be approved by the UNFCCC.

(c) Market-based mechanisms which interact with current schemes but in modified form

One of the options in the Negotiating text specifies an economic mechanism comprised of an emissions trading system and an enhanced clean development mechanism, both of which would be available to parties with quantified economy-wide absolute targets to fulfil respective INDCs as a supplement to domestic actions.   Developing countries would benefit from CDM project activities on a voluntary basis.

One of the options set out in the Negotiating Text in relation to this, however, is that all parties should actively promote the voluntary cancellation of CERs including by subnational entities and the private sector with a view to fostering their engagement with mitigations actions and further enhancing the environmental integrity of the mechanism.  Parties that put forward a financial pledge or target in their INDC would be entitled to use the amount of CERs cancelled on their behalf to comply within their financial targets and pledges but not their mitigation obligations.

Therefore, it is possible that while the current CDM and JI mechanisms may continue, they will be modified and units currently held will not be valid from 2020.

(d) No market-mechanisms

One option in the Negotiating text is to have no market mechanisms.  All current units would be cancelled in 2020.

3.1 Likely outcome

There is not enough information available currently to predict the outcome of negotiations on market-based mechanisms; however, one of the options set out in the Negotiating Text describes the intention of market mechanisms in terms of:

(a) mobilising the widest range of potential investments for adaptation and mitigation;

(b) creating incentives for early action;

(c) incentivising and coordinating effective mitigation and adaptation actions from the broadest range of actors, including the private sector, to support the implementation of the Paris Agreement;

(d) ensuring consistency with individual commitments;

(e) contributing to the sustainable development of the host country; and

(f) generating resources through a levy to enhance climate resilient investment in developing countries.

Given these benefits that market mechanisms provide, and the fact that some countries are clearly expecting to rely on them to an extent, it seems unlikely that they would be extinguished altogether.  Potentially some form of carbon trading market will continue from 2020.  It should be noted, however, that emphasis is placed in many of the options set out in the text on ensuring that any market mechanism supplements domestic action, which should remain the priority of each country.

It seems likely that if market mechanisms do remain, they will be modified in some way.  The use of ERUs and CERs for compliance under the Kyoto Protocol freed up AAUs, exacerbating the issue of oversupply and contributing to the reduction in their value (and equivalent EU Allowances under the EU Emissions Trading Scheme).  It is probable therefore that this issue will be in the minds of the negotiating parties in Paris and will affect the decisions made on market-mechanisms.  If market mechanisms do remain after 2020, then focus will be placed on developing accounting rules for their use, perhaps through a central governing body, to ensure there is no double counting and the integrity of the system is protected. The Conference of the Parties would perhaps define principles, modalities, procedures and guidelines in particular for verification, reporting and accountability of the economic mechanism.

The use of market mechanisms may therefore be restricted, perhaps in one or more of the following ways:

(a) a cap may be imposed on the use of carbon trading mechanisms to ensure the majority of mitigation commitments are domestic actions;

(b) the mechanisms may only be made available to developing countries; or

(c) the mechanisms may only be made available to parties with quantified economy wide absolute targets for the mitigation component of their INDC.

The European Commission has stated that it wants to see the JI and CDM schemes further reformed in order to improve their environmental integrity and efficiency, for example, through more use of standardised baselines and alternative ways of assessing additionality.  For advanced developing countries, the European Commission believes that CDM offsets should be replaced over time by the new market mechanism covering broad segments of the economy and incentivising net emission reductions. CDM would then be focused on least developed countries.

It is difficult to answer the questions raised with certainty at this point, given the early stage of negotiations.  It will be necessary to review how the matter progresses in Paris at the end of 2015