International carbon pricing refers to carbon pricing initiatives that have the potential to cover the whole world. This includes:
Initiatives under the United Nations Framework Convention on Climate Change (UNFCCC):
Initiatives outside of the UNFCCC:
International carbon pricing took off with the introduction of the flexibility mechanisms under the Kyoto Protocol. Adopted at the third Conference of the Parties (COP) to the UNFCCC held in Kyoto, Japan, in December 1997, the Kyoto Protocol committed industrialized country signatories (so-called “Annex I” countries) to collectively reduce their GHG emissions by at least 5.2 percent below 1990 levels on average over 2008–2012. Annex I countries could fulfil their commitments through domestic actions or the use of three flexibility mechanisms IET, JI and CDM. The amendment adopted in Doha, Qatar, in December 2012 provided a basis for the three Kyoto mechanisms to continue for 2013–2020. The IET, JI and CDM were of significant relevance in the creation of cross-boundary carbon markets.
Looking ahead, carbon pricing can play a pivotal role to realizing the ambitions of the Paris Agreement and implement the Nationally Determined Contributions (NDCs). Article 6 of the Paris Agreement provides a basis for facilitating international recognition of cooperative carbon pricing approaches and identifies new concepts that may pave the way for this cooperation to be pursued. Paragraph 136 of the first COP 21 Decision (Adoption of the Paris Agreement) recognizes the important role of providing incentives for emission reduction activities, including tools such as domestic policies and carbon pricing. Many of the plans submitted to the UNFCCC recognize the important role of carbon pricing, with about 100 countries planning or considering carbon pricing mechanisms in their intended NDCs.
International Emissions Trading (IET) is an international ETS set up with the intention to allow Annex I countries to achieve emission reductions at least cost. However, individual countries made policy decisions related to other priorities, and their national context, and did not necessarily optimize their emission reduction efforts on carbon price alone. This heterogeneity of national policies meant that the IET did not achieve a least-cost outcome as originally intended. IET was also hindered by a lack of clarity about environmental outcomes, impacting its attractiveness for sovereign buyers.
The Joint Implementation (JI) and Clean Development Mechanism (CDM) are offset mechanisms under the Kyoto Protocol under which entities from Annex I Parties could participate in low-carbon projects and obtain credits in return.
- The CDM is the market-based mechanism that has involved the largest number of countries—both developed and developing—in efforts to reduce GHG emissions. It grew to a scale that enabled significant emission reductions and financial flows to developing countries. Developing countries can take no-regret actions and participate voluntarily in emission reductions and removal activities through the CDM. The emission reductions are then transferred to Annex I countries to meet their targets. By the end of 2014, the CDM supported investments worth approximately US$90 billion in GHG emission reduction projects in developing countries. The CDM has confirmed that offset mechanisms have the capacity to mobilize capital efficiently toward cost-effective low-carbon investments.
- The JI has been less successful than the CDM in terms of emission reduction achievements as it faces a dual challenge of the lack of countries’ ambition and the uncertainty over the future regulatory infrastructure to issue credits. Most of the credits were issued without the supervision of the Joint Implementation Supervisory Committee, triggering some speculation on the level of rigor applied.
By 2012, the demand for Kyoto credits—Certified Emission Reductions (CERs) from CDM and Emission Reduction Units (ERUs) from JI—started to get saturated. It became clear that the Kyoto credits already issued were enough to fulfill most of the demand, including from the EU, which was the biggest source of demand historically. As no other substantial source of demand for Kyoto credits currently exists, this has led to sustained low prices for CERs and ERUs. Some carbon pricing initiatives at the national level provide the possibility of demand for CERs, such as in Korea, Mexico and South Africa, although only domestic CERs are accepted in these initiatives and the demand is limited. The upcoming Carbon Offsetting and Reduction Scheme for International Aviation (CORSIA) could represent a significant new source of demand for CERs.
The voluntary market caters to the needs of those entities that voluntarily decide to reduce their carbon footprint using offsets. By the end of 2015, the cumulative issuance on the voluntary market was 330 million credits, which is about one-eighth the volume of CDM and JI issuances. However, annual issuance levels and prices have been more stable over time than in the Kyoto credits market. The demand is mainly driven by voluntary offsetting in the private sector in jurisdictions without mandatory carbon pricing.
Results-based Climate Finance (RBCF) is a funding approach where payments are made after pre-defined outputs or outcomes related to managing climate change, such as emission reductions, are delivered and verified. Some RBCF programs purchase compliance emission reduction units, including CERs and ERUs, helping bridge the current lack of demand for these units. Some of these programs include the World Bank’s Carbon Initiative for Development (Ci-Dev) and the Pilot Auction Facility for Methane and Climate Change Mitigation (PAF), and the German government’s Nitric Acid Climate Action Group. Elements of the existing carbon market infrastructure, such as the CDM monitoring, reporting and verification (MRV) requirements, have been incorporated into these programs. Other programs not specifically designed for compliance markets use RBCF as a direct funding mechanism and were built from the ground up. Such programs include the Performance Based Climate Finance Facility (PBC) in Latin America financed by the European Commission, KfW and CAF, and the World Bank’s Transformative Carbon Asset Facility (TCAF). These programs focus on the implementation of large scale sectoral or policy-level emission reduction programs.
Member States of the International Civil Aviation Organization (ICAO) adopted the first global sectoral carbon pricing initiative—the Carbon Offsetting and Reduction Scheme for International Aviation (CORSIA)—on October 7, 2016. This is a global carbon offsetting initiative that aims to stabilize net emissions from international aviation at 2020 levels; any additional emissions above 2020 levels will have to be offset. According to researchers and analysts, the CORSIA has the potential to generate demand for carbon assets of around 2.5 GtCO2e between 2021 and 2035, which is comparable to the cumulative volume of Kyoto credits issued so far. Demand will be shaped by rules on the type of credits that will be eligible for airlines to purchase to comply with the CORSIA. ICAO’s Committee on Aviation Environmental Protection will recommend a set of rules for eligible credits; adoption of these rules by the ICAO Council is expected by 2018.
Article 6 of the Paris Agreement recognizes that Parties can voluntarily cooperate in the implementation of their NDCs to allow for higher ambition in mitigation and adaptation actions:
- Articles 6.2–6.3 of the Paris Agreement cover cooperative approaches where Parties could opt to meet their NDCs by using internationally transferred mitigation outcomes (ITMOs). ITMOs aim to provide a basis for facilitating international recognition of cross-border applications of subnational, national, regional and international carbon pricing initiatives.
- Articles 6.4 establishes a mechanism for countries to contribute to GHG emissions mitigation and sustainable development. This mechanism is under the authority and guidance of the COP serving as the meeting of the Parties to the Paris Agreement (CMA). It is open to all countries and the emission reductions can be used to meet the NDC of either the host country or another country. The mechanism is intended to incentivize mitigation activities by both public and private entities.
The operationalization of the mechanisms under Article 6 is one of the key challenges which need to be overcome to enable carbon pricing to deliver on its potential for cost-effective decarbonization. Modalities to ensure environmental integrity and avoid double-counting, enable greater ambition and promote sustainable development are at the core of the discussions under the UNFCCC.