Road to a more efficient carbon market

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    • Road to a more efficient carbon marketRoad to a more efficient carbon market
    01 December 2021


    By UOB Asset Management

    In Part 3 of our series on COP26 outcomes, we look at efforts to improve the mechanisms and impact of the global carbon market, and what this means for Asia.


    As the clock ticked down to the close of COP26, negotiations stood at a standstill on how to advance the global carbon market. It was only far into overtime that revisions to Article 6 of the Paris Agreement finally received the go-ahead. The last-minute deal was a long-awaited legitimisation of the rules for carbon credit trading.

    This is a positive for Asia and other developing countries, especially those still supporting substantial forest cover. Many have already launched carbon markets and the implementation of global rules will benefit them both as providers of carbon credits, and as recipients of environmental project investments.

    The birth of the carbon market

    Article 6 as drafted in 2015 was aimed at assisting governments and the private sector to implement carbon emission limits through voluntary international cooperation. By creating a global Emissions Trading System (ETS), countries with lower emissions would be allowed to sell their excess allowances to larger emitters, with an overall cap on greenhouse gas (GHG) emissions, ensuring net reduction.

    It was anticipated that the supply and demand of emissions allowances would lead to the establishment of a global carbon price that could be directly charged to polluters. This market-adjusted price meant that nations and even corporations exceeding their targets would directly bear the costs of global warming, thereby paving the way for a low-carbon future.

    The carbon market is currently valued at over US$100 billion and consists of CCMs (Compliance Carbon Markets comprising trading across country and regional regulators) and VCMs (Voluntary Carbon Markets comprising trading by companies, institutions and individuals). It is widely believed that these markets have the potential to be much bigger, but pre-COP26, had faced liquidity limitations, unclear price mechanisms, and non-standard trading rules.

    Rules clarity

    COP26’s Article 6 deal addresses these issues and ensures that the Paris Agreement becomes fully operational. It provides solutions to a number of previously contentious issues, including an approach to avoid double counting and an agreement on the carry-over of pre-2013 credits. The deal also offers a way forward on the proposed taxation of certain carbon trades, originally designed to help poorer nations but unacceptable to the richer ones.

    These refinements help to link national and regional carbon markets. They allow regulators to connect the dots between local carbon trading schemes and the international transfer of carbon credits via bilateral and multilateral agreements. They also provide countries with an accounting framework for carbon trading.

    In addition, the amendments increase the opportunities for VCMs. According to a report by GIC, Singapore EDB and McKinsey, VCMs are currently worth US$300 million, but are expected to grow to between US$5 to 30 billion by 2030. The report notes that carbon markets are rapidly approaching a critical mass from an investments perspective. Private sector investments in projects that increase the supply of carbon credits and enhances VCM governance can help establish a virtuous cycle for the expansion of this market.

    Active participation from Asia

    Despite making up some of the world’s top polluters, Asian countries’ many low-lying cities make them particularly vulnerable to climate risks. An active carbon market also allows Asian countries to attract investments in emission-reduction technologies. As such, even pre-COP26, Asian regulators had already taken substantial steps towards carbon trading and pricing.

    Japan was one of the first countries in Asia to introduce a city-level ETS. Discussions on carbon pricing were already in the works by the country’s Environment and Economy, Trade and Industry ministries. Similarly, in the lead-up to COP26, the Taiwanese Government announced that it would design a carbon pricing mechanism for large emitters to be implemented in 2023.

    Within the ASEAN region, Singapore was the first to introduce a carbon pricing mechanism in January 2019. The carbon tax is currently set at S$5 per tonne, but is due to be revised in 2024 to reflect the increased costs of carbon emissions. This revision is slated to be announced in the next budget.

    Indonesia, given its pledge to reduce 29 per cent of its greenhouse gas emissions by 2030, recently passed its Harmonized Tax Law (UU HPP). This law sets out a carbon tax rate of IDR30 per kg of CO2e and enforces an emissions cap. Industrial plants that exceed the cap will be taxed accordingly.

    Malaysia, given its ambitious commitment to reduce 45 per cent of greenhouse gas emissions by 2030, recently expedited its domestic emission trading scheme (DETS). This scheme is now expected to be implemented at a quicker pace by leveraging the international carbon pricing frameworks enabled by the COP26 agreement.

    Achieving net zero

    For some, the carbon trading rules do not go far enough. In particular, there remains concerns that the potential for double counting has not been fully eliminated and carbon credits that have been used are not retired.

    Nevertheless, six years in the making, the Article 6 amendments are expected to have a big impact on the viability of the global carbon market. As seen in Asia, emission trading systems have already been introduced and many carbon markets have started to see an increase in trading volumes. The COP26 agreement provides the structure that these markets need to function properly. They also help establish a global platform for the private sector to get involved in emission reduction initiatives. Rather than just relying on governments to meet their net zero targets, a liquid and transparent carbon market allows companies and private investors to help close the gap towards the 1.5 degrees climate warming goal.

     

    This article was first published in UOBAM Insights. Visit UOBAM Insights for more investment insights and perspectives.

     

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