Swiss/Peru offset link forged in Paris Agreement – Have we seen this all before?

It’s been dubbed a first of its kind – a new offset deal between Switzerland and Peru under the Paris Agreement. But how ground-breaking is this deal? And has there been any real change from the old offset efforts under the Kyoto Protocol of the past? Because of the postponement of COP26 in Glasgow, rules on carbon markets under the Paris Agreements are still in limbo. A glaring question is therefore, how Switzerland can strike a deal with Peru under the Paris Agreement framework without clear rules governing these new offset trading mechanisms.

In this Watch This! Edition, we are also happy to share an explanation on the new deal by Swiss carbon market expert Axel Michaelowa. But first, let’s take a walk through the historic context on how we got to this point.

A walk down carbon offsets memory lane: Back in 1997 in the beautiful royal city of Kyoto, Japan, a UN deal on climate change called the Kyoto Protocol (KP) was agreed. Among many of the tools that were designed for its implementation, there were the ‘flexible mechanisms’. These were essentially carbon offsetting tools to achieve low cost CO2 abatement in developing and emerging economies. In the beginning, this new carbon market seemed a win-win for both developed and developing countries. With one permitted the right to pollute with a low cost exoneration and the other finding a new source of international financial investment. This seemed like a great strategy in the name of climate action, and in 2005 after the ratification of the KP, the mechanisms such as the Clean Development Mechanism (CDM) were kicked off.

In the years that followed, these new carbon markets entered their gold rush period, and enthusiasm for market backed solutions was at an all-time high. But not long into this 15 year history, these mechanisms began to flounder both as a result of designs and participation.

A number of scandals uncovered by Carbon Market Watch – then known as CDM Watch –  found that enormous perverse incentives existed in its core which led to the overproduction of highly polluting industrial gases. One of the market’s biggest buyers – the EU – quickly abandoned its support. Additional structural problems created huge oversupply of reduction units or ‘credits’ on the market, and eventually the price crashed. The heart of the UN’s flagship international carbon market went into cardiac arrest. For the last decade therefore, these mechanisms have remained largely on life support, with carbon prices that barely pay for UNFCCC administration costs let alone incentivise low carbon project deployment.

Fast forward to 2015 and the COP21 climate conference, in Paris. CMW played an instrumental role throughout this event helping to place robust environmental integrity language into the article 6 (the section on market mechanisms) in the now famous Paris Agreement.  Following a year of official ratifications, the Paris Agreement was finally approved by countries and rules on how to implement it could be drawn up and agreed. Then in Katowice in 2018 something didn’t go quite right – while all other elements of the Paris Agreement were concluded, article 6 rules were not. Many of the underlying systemic issues with offset schemes that were not fully dealt with in Paris were still unsurprisingly there. Notably CMW had raised many of these concerns in 2015, and doubled-down again in 2018, which didn’t help negotiators that were striving to resolve them quickly and quietly. That was two years ago and the rules are still not finalised – even if the Paris Agreement enters into force in less than a month. The latest UN climate talks in Madrid also ended in a deadlock. The most contentious issues continue to be the fate of the old Kyoto era credits and the danger of counting one emission reduction towards multiple climate commitments. Another key element is the promotion and respect of human rights and the rights of local communities which should be at the core of any climate action. Due to the coronavirus pandemic, the negotiations will now continue only in 2021.

The Swiss-Peruvian deal explained by Swiss carbon market expert Axel Michaelowa:

  1. What do you think about this new offset deal between Peru and Switzerland?

The Peruvian-Swiss agreement is an important step for the operationalisation of bilateral market cooperation under Article 6.2. The agreement for the first time defines the tasks of the two governments involved in such a collaboration, and defines new terms such as “recognition” of ITMO (Internationally Transferred Mitigation Outcomes) transfers. Given that it includes a number of important principles to safeguard the integrity of carbon market transactions it puts the bar high. For example, net zero emissions transition by 2050, consideration of all existing and planned mitigation policies, and avoidance of fossil fuel lock-in are among the principles specified in the agreement. The agreement also requires full accounting through corresponding adjustments. Therefore, it could lead to a race to the top in Article 6.2, which is sorely needed to generate trust in the ability of market mechanisms to raise ambition and contribute to the long-term Paris Agreement goal. Moreover, the respect of human rights and prevention of social conflict is an explicit target, as well as the fight against corruption. Compared to a scenario of countries trying to sell large quantities of spurious emissions credits, we fortunately have seen a good “start shot” of Article 6.

  1.     There is little detail on the specific types of activities that will be used by Peru to generate the offsets for transfer to Switzerland. What do you suspect they will be, i.e. what sectors or industries are involved?

The agreement is an umbrella under which different actors are free to develop actions, it thus does not give a direction regarding the activities. This is good as the market will be most effective if a wide range of activities is undertaken. So far, Peru has focused on actions in various sectors, such as low carbon cement, low-carbon waste management and efficient cookstoves. With the agreement in place, the emergence of activities will surely accelerate.

  1. What would a deal like this mean for Switzerland in terms of meeting their climate target?

The Swiss Parliament has recently voted on the CO2 law which specifies that only* 25% of the 2030 mitigation target can be reached by importing emissions credits. For the decade 2020-2030 this amounts to around 35 million t CO2eq. Switzerland wants to set up a range of bilateral agreement in order to allow a differentiated supply of credits.

  1. If a country can over achieve its target, do you think this is a good approach for Peru and others to sell this extra abatement to foreign countries? Why don’t they simply increase their own national targets?

Developing countries do not have unlimited resources for climate change mitigation. Thus mobilizing mitigation beyond the NDC target through carbon market revenues is important. The ambition can be increased by showing through concrete activities that mitigation costs are less than generally assumed. Also, after the end of the crediting period, the mitigation will accrue to the host country as long as the mitigation technology remains operational. Thus in the next NDC update, the ambition can be increased by the sum of the mitigation generated by all Article 6 activities whose crediting periods have ended.

  1. How can a deal like this be reached between countries if the rules of Paris Agreement’s carbon markets have not yet been finalised?

Given that Article 6.2 activities will be governed only to a very limited extent by international rules, and many countries think they can do market collaboration even in the absence of formal agreements on Article 6 rules, it is important that we get a high quality first example of such an umbrella agreement that ensures full transparency. The Swiss have fortunately been able to do so.

Carbon markets are therefore officially back under the UN’s new Paris Agreement.  So for anyone who remains sceptical or wished to see the end of offsetting this news of the Swiss/Peru link will probably not please you. Many will see this as a remake of an old sitcom that didn’t quite work the first time and in many ways they are right. Carbon reduction projects like Axel points out, can bring lasting impacts for a country through the emission reducing finance they provide once the crediting period is over. But what if we considered alternative financing methods, is there not a case to be made?

Whether for or against, within UN or voluntary systems, carbon market activities will likely be rolled out further as it becomes increasingly challenging for developed countries and their industries to stay competitive while at the same time meeting higher climate targets. However, let us never forget now more than ever the world needs countries to take full and lasting ownership of their pollution. Emission reductions need to firstly start at home and only as an absolute last resort should countries depend on others.  Sadly, it’s difficult to tell how this offset deal sends that message.

*”Comment of the WatchThis editor: The “only” here refers to the 40% which were previously earmarked for imported emission credits. In absolute terms 25% is still a lot.”