The future of global carbon markets

Outlook: an uncertain future

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All countries, developed and developing, reached a climate agreement when the COP 17 Durban Platform was signed at the end of 2011.

Or rather, it was an agreement to agree in the future. Until 2020, climate policy will be driven by the domestic efforts of individual countries.

International policy and the Durban outcome

The main decisions taken in Durban concern a mix of temporary commitments and tools. The temporary commitments were:

  • Implementation of the voluntary “pledge and review” agreements through to 2020, which were previously initiated at COP 15 and COP 16.
  • Extension of the KP for a second commitment period until 2017 or 2020 without the US, Russia, Japan and Canada.
  • The Durban Platform for Enhanced Action — a negotiation track that aims to agree on the targets and scope of a new future climate regime by 2015, applicable to all parties from 2020.

Other important decisions taken in Durban concern mitigation, adaptation, technology and financing tools that need to be further developed over the next four years.

It is important to notice that the nature and scope of the post-2020 agreements is by no means determined. Durban established an Ad Hoc Working Group on the Durban Platform for Enhanced Action, with the mandate to develop “a protocol, another legal instrument or an agreed outcome with legal force under the Convention applicable to all parties.”

The clean development mechanism and new market mechanisms

To date, the Clean Development Mechanism (CDM) has been the main international mechanism for mitigation in developing countries.

However, its slow bureaucratic process, complex design, costs and sensitivity to fraud have all drawn criticism. In addition, to achieve the large-scale emissions reductions that are required to combat climate change, the mechanism has proved limited.

For these reasons, the United Nations Framework Convention on Climate Change has been working on significant reforms while alternative mechanisms have also been proposed to scale up offsetting volumes.

A number of new mechanisms are being considered to scale up offsetting in developing countries, namely:

  • Bilateral and sectoral mechanisms
  • Reducing Emissions from Deforestation and Forest Degradation (REDD+)
  • Credited Nationally Appropriate Mitigation Actions.

These all aim to scale up the CDM significantly. Most of these mechanisms are still being designed and they are not likely to be launched before 2020, but can present significant opportunities to the private sector.

The private sector: role and impact

The effect of carbon markets on a company’s bottom line depends greatly on the maturity of the specific market, the rules and allocation methodology, and whether sectors are able to pass on costs.

When assessing the economic implications for the private sector of the current new trend for carbon compliance markets expanding to developing countries, factors to consider include the type and scope of the global agreement, and whether sectors and markets will be linked. In the short to medium term, the rate of economic development will probably be much more influential than implementation of carbon legislation.

Up to 2020…

Although many businesses around the world will remain unaffected by carbon markets until 2020,those in the US, China, South Korea and Australia will need to look at setting up a carbon management strategy, monitoring emissions, learning how to trade carbon and lobbying the authorities. Firms in emerging markets will also need to start preparing as the shift in economic power from developed to developing economies accelerates.

Until 2020, the impact on the private sector mostly relates to the administrative burden of entering an ETS rather than the negative effects on a company’s balance sheet. During the same period, while the Durban Platform are being implemented, opportunities will exist for businesses to get involved in the design and trials of the scaled-up market mechanisms, with the aim to capitalize later.

After 2020…

The main conclusion regarding the implementation of the Durban Platform is that much uncertainty remains.

The world gave itself four more years to come to terms with battling climate change. Although this may concentrate minds, many questions remain unanswered.

What kind of commitments can we expect? Will there be any new market mechanisms to scale up emissions reductions? What is the effect on the shape and scope of carbon markets? Will companies be carbon constrained in the same way in China, the US and the EU?

These questions lead to three distinct theoretical scenarios:

  • Ambition. A comprehensive, clear and ambitious multilateral agreement takes effect in 2020. All countries take on targets on an equity basis, with the major emitters and industrialized nations generally agreeing to cut emissions and developing countries generally accepting to limit the amount by which they increase emissions. New market mechanisms are implemented.
  • Weak agreement. A weak global agreement is reached, with targets that will not drive serious domestic mitigation. Some new market mechanisms will be implemented.
  • No agreement. There is no agreement whatsoever, the global financial crisis continues and countries pursue other priorities rather than responding to climate change. In effect this shifts us back to unilateralism and a bottom-up approach, where only a number of ambitious countries, regions and local authorities take the problem seriously.

Businesses across the world must prepare for a future where they are carbon constrained.

Firms in developing countries that proactively engage now with low-carbon and adaptation strategies will gain a competitive advantage and reap the benefits later when the countries in which they operate implement carbon policies.

Carbon markets are a key mechanism of future climate finance, but they need to be expanded and reformed. There are high expectations from new scaled-up market mechanisms, but a demand for their credits is essential for them to be effective.

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