Twilight in Baku: The Impact of Article 6’s Full Operationalisation on Carbon Markets

The conclusion of COP29 in Baku marked a historic milestone with the full operationalisation of Article 6 of the Paris Agreement, establishing a comprehensive framework for international carbon markets.These developments unlock the potential for global collaboration on climate action by finalising the rules for the centralised carbon credit mechanism under Article 6.4. By setting universal standards for credit issuance and verification, these frameworks aim to enhance transparency, credibility, and accountability in carbon trading globally.

While these mechanisms are expected to drive significant investment into high-quality carbon credits, they also highlight critical challenges in implementation, such as ensuring equity, transparency, and compliance in both voluntary and compliance markets. The success of these initiatives will depend on effective enforcement and the collective commitment of stakeholders to their integrity and ambition.

Article 6.4 in focus

Source: Calyx Global

At COP29, negotiators finalised the operationalization of the Article 6.4 mechanism, establishing a UN-supervised global carbon credit market. The Paris Agreement Crediting Mechanism (PACM), introduced under Article 6.4, improves on the earlier Clean Development Mechanism (CDM) created under the Kyoto Protocol. The CDM allowed industrialised countries to fund emissions reduction projects in developing nations and earn carbon credits to meet their own climate targets. However, it was often criticised for giving credits to projects that might have happened anyway and for lacking safeguards to ensure real environmental impact.

The PACM addresses these issues by setting stricter rules, such as requiring clear proof that projects would not happen without carbon credit funding, using more cautious benchmarks for measuring emissions reductions, and creating safeguards to protect against setbacks in projects like forestry. These improvements aim to make carbon markets more credible and effective in meeting the goals of the Paris Agreement.

Source: BeZero Carbon

However, the operationalisation of Article 6.4 is not without controversy. Experts argue that centralised oversight could slow project approvals and lead to bureaucratic bottlenecks. Additionally, concerns persist about whether the mechanism will prioritise projects in developing countries that lack the institutional capacity to navigate complex compliance requirements. Critics, including nations like Tuvalu, have also flagged governance challenges, noting how the Article 6.4 Supervisory Body expedited processes to avoid political blockages, bypassing traditional CMA (Conference of the Parties) approval protocols.

Implications of the PACM for carbon markets

For the compliance market

The operationalization of Article 6 is expected to significantly enhance compliance markets by introducing stricter standards and encouraging greater government participation. These frameworks will expand the portfolio of high-quality credits available to countries, supporting their efforts to meet Nationally Determined Contributions (NDCs). Additionally, they promise to scale investment into projects that align with both climate and sustainable development goals.

For the voluntary carbon market

The voluntary carbon market (VCM), where corporations and individuals purchase offsets to meet net-zero commitments, is poised for significant changes following COP29. Decisions on Article 6 have introduced higher-quality standards for carbon credits, raising the bar for credibility in the VCM. While this could attract more participants by increasing market legitimacy, it also poses risks for projects that fail to meet the new benchmarks. 

For example, nature-based solutions (NBS) projects, such as afforestation and wetland restoration, which dominate the current voluntary market, may face challenges aligning with Article 6 criteria. If these projects face difficulties aligning with Article 6 criteria, they may lose access to key funding streams. As a result, companies relying on offsets for their net-zero claims will need to reassess their strategies, potentially shifting toward more ambitious internal emissions reductions.

The convergence of voluntary and compliance markets

Both markets play a critical role in bridging the $3.5 trillion annual investment gap needed to achieve global net-zero emissions by 2050. Compliance markets focus on driving decarbonization in regulated sectors, while voluntary markets provide the flexibility to fund innovative and high-risk projects, often in hard-to-abate sectors. As Sylvera notes, the integration of these markets enhances their collective ability to mobilize capital for critical climate solutions, whether through supporting nature-based projects or scaling technological solutions for carbon removal.

Opportunities of convergence

From the perspective of compliance markets, the convergence with VCM creates opportunities for scaling investment and increasing liquidity. Private sector engagement in VCMs has traditionally provided a testing ground for innovative project types, such as carbon capture and storage or community-driven reforestation initiatives. With the introduction of Article 6-compliant standards, these innovations can more seamlessly transition into compliance frameworks, enabling governments to tap into a wider array of emissions reductions. 

Convergence also enhances market credibility by ensuring that credits in both markets meet rigorous standards. This integration fosters greater investor confidence, ultimately attracting the capital needed to scale impactful projects.

Challenges of convergence

Despite its potential, the convergence of voluntary and compliance markets raises critical governance and equity questions. Wealthier countries and corporations may dominate access to high-quality credits, leaving less-advantaged actors marginalised. Additionally, blending these markets could dilute the ambition of compliance mechanisms, allowing governments to over-rely on external credits rather than pursuing domestic emissions reductions.

Aligning carbon credit prices with market realities

Notably, compliance credits are generally priced higher than voluntary credits. This price difference reflects the increased cost of regulatory compliance and the assurance of environmental integrity associated with compliance markets. With convergence and alignment with PACM standards, carbon credit prices are likely to rise to match pricing in the current compliance market.

As carbon credit prices rise to reflect stricter environmental integrity standards and increased market oversight, these higher prices could help address persistent supply and demand-side challenges in carbon markets.

• On the supply side: Higher prices provide greater financial incentives for project developers to invest in high-integrity initiatives, particularly those involving nature-based solutions and technologies like carbon capture and storage. These incentives are critical to scaling up the availability of credits that meet rigorous quality benchmarks. For instance, GenZero’s 2023 report highlights that aligning carbon credit revenues with the true cost of abatement is necessary to close the funding gap for large-scale REDD+ and other land-use projects, which have historically struggled to secure sufficient capital.

• On the demand side: Increased prices encourage corporate buyers to prioritise quality over quantity, aligning their purchases with robust net-zero commitments rather than less ambitious carbon-neutral claims. This shift towards more robust commitments will also go some ways towards mitigating the risk of greenwashing. Additionally, higher prices may spur innovation in credit types and project methodologies, ultimately broadening the market’s scope and enhancing its overall credibility.

These developments indicate that rising carbon credit prices, far from being a hindrance, could be instrumental in addressing systemic issues in both voluntary and compliance markets, driving investment toward high-quality, high-impact solutions. With the level of regulation expected to rise in accordance with Article 6.4 standards and methodologies, the convergence of both markets may potentially have an upward effect on general carbon market prices as the greater integrity of carbon projects becomes reflected in these costs. A 2023 report by the World Bank found that existing carbon credit prices were insufficient to cover the actual costs of many credit-generating activities, underscoring the importance of aligning prices with market realities to unlock further investment.

Looking ahead

The decisions made at COP29 mark a watershed moment for the evolution of global carbon markets. After years of negotiation and stagnation, the full operationalization of Article 6 has set the stage for eventual convergence between voluntary and compliance markets. As both markets converge, rising carbon credit prices are likely to incentivize higher-quality projects and align market mechanisms with real-world costs.

However, to fully realise the potential of Article 6, careful attention must be paid to ensuring that these mechanisms support equitable access to funding and deliver meaningful emissions reductions globally. COP29 may have charted the course, but the success of these initiatives will ultimately depend on the collective will of stakeholders to implement them with integrity and ambition.

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This report is independent of the views of the National University of Singapore. 

References: BeZero Carbon, Calyx Global, COP29 Azerbaijan, GenZero, Montel, OECD, Sylvera, The Policy Center for the New South, UNCTAD, World Bank