Canada Energy Transition Blog

COP26: Key outcomes and impact on voluntary carbon markets

Dec 22, 2021 9 MIN READ
Authors
Maeve O’Neill Sanger

Associate, Regulatory, Indigenous and Environmental, Calgary

Sander Duncanson

Partner, Regulatory, Indigenous and Environmental, Calgary

Jacob A. Sadikman

Partner, Commercial, Toronto

Jordan Mulligan

Associate, Disputes, Calgary

Ice breaking off glacier

On November 13, 2021, the 26th Conference of the Parties (COP26) to the UN Framework Convention on Climate Change concluded after two weeks of meetings in Glasgow, Scotland. Initially scheduled to end on November 12, COP26 was extended until the following evening to reach agreement on the Glasgow Climate Pact[1] (the Pact). This post provides a brief overview of the key commitments made in the Pact and at COP26 that will impact carbon markets and policy in the years ahead, with a particular focus on their possible implications for voluntary carbon markets.

Glasgow Climate Pact

COP26 followed on the international commitments made under the Paris Accord by Canada and other nations. The Pact reaffirms those nations’ commitment to holding the rise in global average temperature to well below 2°C above pre-industrial levels and pursuing efforts to limit the temperature increase to 1.5°C. Nearly 200 countries signed on to the Pact.

To mitigate climate change, the Pact calls on parties to submit new targets (called Nationally Determined Contributions) to the United Nations Framework Convention on Climate Change (UNFCCC) by the end of 2022 to align with the Paris Agreement’s global temperature goals and to accelerate global efforts to cut carbon emissions by 2030. It also asks parties to accelerate the steps necessary to “transition towards low-emission energy systems”, including by scaling up clean power and energy efficiency and accelerating the “phase-down of unabated coal power and inefficient fossil fuel subsidies”. This text represents a weakened commitment to reducing reliance on coal power relative to  earlier drafts of the Pledge that called on parties to “phase-out” unabated coal power. China and India, which remain heavily reliant on coal, insisted on the change, which has drawn criticism.

The Pact also highlights a global need to scale up climate change adaptation measures and finance, calling on developed countries to contribute greater funding for climate change adaptation and to provide greater clarity on their pledges to finance both mitigation and adaptation strategies in developing countries. The Pact asks for greater support from developed countries for measures to address the loss and damage caused by climate change, particularly in developing countries.

Carbon markets

To meet ambitious voluntary emissions reductions of carbon dioxide and other greenhouse gases, national governments and the constituent members of their private sectors will need to rely on emission offsets and similar financial products, commonly referred to by the blanket term “carbon credits”, to notionally reduce or offset their total emissions.

Carbon credit markets are broadly grouped into two markets: compliance and voluntary. The compliance market is comprised of greenhouse gas emitters, carbon credit generators and traders. Greenhouse gas emitters in compliance markets are required by government regulations to reduce their emissions; these emitters may purchase carbon credits to offset any carbon emissions in excess of the allowable threshold to bring themselves into compliance with the applicable regulation. Carbon credit generators generate and sell those carbon credits through their emission reduction activities or technologies. This carbon credit generating and selling process is governed by one of several approved offset quantification protocols. The compliance market in Canada exists both provincially (such as TIER in Alberta) and federally (i.e., the Output-Based Pricing System under the Government of Canada’s Greenhouse Gas Pollution Pricing Act), both of which provide for carbon credit generation and utilization.

The voluntary carbon markets also bring together emitters (governments, corporations or individuals) and carbon credit generators, but differ from compliance markets in that voluntary credit purchasers are engaging in transactions on a voluntary basis to meet environmental, social and corporate governance (ESG) policies to reduce their carbon footprints. Such transactions are not required by law (though some regulated emitters participate in the voluntary market as part of their carbon management business policies), and the credits that emitters purchase on voluntary markets do not have to be recognized by any regulator or governmental authority under any particular carbon credit regulatory scheme (though they need to meet similar validation standards and protocols to be considered legitimate). Voluntary carbon credits have historically been priced below the pricing of credits in compliance markets and continue to struggle with limited liquidity.

Whether traded in the compliance market or the voluntary market, and however it may be called in different jurisdictions, a carbon credit is a notional financial product representing the avoidance or reduction of carbon dioxide or equivalent greenhouse gas from the atmosphere. Since atmospheric carbon emissions are not constrained by borders, global voluntary carbon markets — and the institution of standards to facilitate their growth — are widely considered by experts as an effective lever parties can use to help them meet the Pact’s climate change targets.

What happened at COP26?

A key goal heading into COP26 was to establish rules for a global carbon credit market. The Pact includes the parties’ agreement on rules under Article 6 of the Paris Agreement to create a market for units representing emissions reductions, called Internationally Transferred Mitigation Outcomes (ITMOs).[2] Countries may trade ITMOs, and some credits previously created under the Kyoto Protocol will be allowed to circulate for a limited period of time.

Under the guidelines and rules adopted in the Pact, ITMOs must be “real, verified, and additional” and must be adjusted and reported. The new guidelines also establish a centralized database to record ITMOs and identify inconsistencies, as well as a centralized accounting and reporting platform. The rules set out the requirements that activities must meet to be credited under Article 6.

Implications for voluntary carbon markets

There is currently a wide pricing range for voluntary carbon credits, depending on the nature and quality of an offset-generating project, the location and vintage year of its generation and the degree of difficulty in verifying the legitimacy of its offsetting activity. The Pact seeks to increase the standardization and transparency of carbon credits generally, which should lead to increased carbon credit price standardization, at least within project types.

It is also expected that standardization of carbon credit recognition principles and further development of credit trading platforms and exchanges will facilitate an increase in credit liquidity. Currently, most carbon credit transactions are privately negotiated bilateral transactions, with some transactions being brokered by aggregators and other brokers specializing in specific offset-generating industries. Generating a standardized set of credit validation and trading rules should reduce fragmentation among the current voluntary carbon credit registries and facilitate more exchange-based and secondary market transactions.

These developments are creating opportunities for businesses in the agricultural and agribusiness sectors, among others. Currently, agriculture-oriented offset protocols in Canada are limited — the B.C. Forest Carbon Offset Protocol is still in the consultation stage, and the Alberta government has withdrawn its Conservation Cropping Protocol. However, experts believe that carbon farming and agriculture-oriented practices will be the source of significant worldwide growth in voluntary carbon credits. What remains to be seen is how international standards for carbon credits will address the risk that something which meets the “additionality threshold” (the requirement that the emissions reduction is additional to what would occur under the status quo) in one jurisdiction may not meet the additionality threshold in a different jurisdiction.

Often, the lowest-cost emissions reduction projects can garner high prices due to their ease of verification, among other factors. It is estimated that soil management and other agriculture management practices are significant low-cost areas of potential future carbon sequestration. This is significant for Canada’s agriculture and livestock sectors, which are comparatively advanced in credit-generating operating practices. As a corollary, Canada’s robust tech sector — drone technology made in Canada and other technological developments, including blockchain applications — could play an important role in low-cost verification and aggregation for voluntary carbon credits. As a result, the evolution of voluntary carbon markets following COP26 may stimulate the agribusiness sector’s carbon-related revenues and grow the verification-related tech sector, notwithstanding the dearth of “made in Canada” compliance market protocols for those technologies.

Greater recognition of voluntary carbon credits as a reliable and credible future revenue stream can facilitate financeability of offset-generating projects and spur investment in the technologies that can generate carbon credits. Renewable power developers and others whose credits have been recognized in certain compliance carbon credit markets have been leveraging these revenue streams for years by adopting long-term carbon credit offtake contracts. This can create significant value accretion for industries that have not benefitted from carbon credit revenue streams to date, such as farming.

Voluntary markets can also provide options for emissions sequestration projects that may not fit the current carbon capture, utilization and storage frameworks being developed, such as in Alberta, where the number of carbon sequestration projects to date is limited. In addition, greater availability of voluntary carbon credits may facilitate the acceleration of voluntary ESG initiatives among non-regulated industries, perhaps because of the dampening effect on price that may follow. Credibility and verifiability of credits and demonstrated presence of an offtake market will be critical to securing financing for offset-generating projects, many of which involve significant up-front capital investments.

However, some complications will remain. It may be very difficult to achieve standardization among sovereign jurisdictions (whether national or subnational), many of whom have already implemented their own carbon regulatory schemes. By way of example, who owns the credit from a particular practice — the party that generates emissions reduction technology or products, or the party that chooses to use such technology or products? The answer to this question varies between jurisdictions.

Further, fragmentation in the industry will continue for as long as carbon registries do not cooperate with each other. Additionality needs to be assessed in jurisdiction-specific ways. For instance, renewable power is independently cost-effective (or required by law) in some jurisdictions. At the same time, fairness must be balanced between nations (for example, those that already employ good crop management and grazing management practices and those that do not). These challenges will likely give rise to fungibility and trading issues that will need to be managed as the global carbon credit market matures.

Other implications of COP26

In addition to carbon credits, the commitments Canada made at COP26 — while not legally binding — will likely influence Canadian domestic policies across several sectors, including energy.

The first of these changes was signaled during COP26 with Canada’s announcement that it will place a firm cap on emissions from the Canadian oil and gas sector and impose reductions on it to reach net-zero by 2050. Canada also signed a statement during COP26 which pledged to “end new direct public support for the international unabated fossil fuel energy sector by the end of 2022, except in limited and clearly defined circumstances that are consistent with a 1.5°C warming limit and the goals of the Paris Agreement” and to “prioritize our support fully toward the clean energy transition”.

These statements signal that the federal government is moving away from supporting any domestic fossil fuel sectors that are not engaged in carbon capture or other abatement strategies. The Pact and other outcomes of COP26 are also likely to lead to a greater domestic focus on reducing methane emissions and increasing sustainable forestry and agriculture practices, both of which were key issues at COP26.


[2] Drafts of the guidelines and rules can be found online: <unfccc.int/sites/default/files/resource/cma2021_L18_adv.pdf>; <unfccc.int/documents/309980>. The UNFCCC has yet to publish final versions on its website.