Carbon Trading Post Baku : Part I

The recently concluded COP29 in Baku did not hit the headlines as prominently as some previous COPs. Comparatively, it was a tame affair. And yet, it registered some progress. The key outcomes of the deliberations included an agreement to put in place a UN-administered carbon trading framework; a structured operationalisation plan for the Loss and Damage Fund with contributions from developed countries and new donors, including private sector partnerships; and agreements on scaling investments in ecosystems, such as forests and wetlands, to sequester carbon and enhance resilience. Wealthier nations also pledged to meet and exceed the $100 billion annual climate finance goal, focusing on adaptation in vulnerable regions. While these outcomes may not seem groundbreaking, they represent incremental progress.
Among these, the most significant outcome—with extensive ramifications—is the agreement on Global Carbon Credit Standards. Nations finalized rules under Article 6 of the Paris Agreement, establishing a UN-administered carbon trading framework. This agreement aims to enhance transparency, accountability, and reduce greenwashing concerns while supporting private and state-level carbon credit exchanges. The approved standards are expected to mobilize significant investments, potentially driving the carbon credit market’s value to $250 billion annually by 2030, aligning carbon offsets with ambitious climate targets. These developments represent a crucial step in operationalizing international efforts to combat climate change.
Provisions of the Baku Agreement
The Baku Agreement operationalizes Article 6 of the Paris Agreement and provides a global framework for carbon markets. It introduces standardized rules to prevent double counting of carbon credits and ensure environmental integrity. The operationalization of Article 6.4 establishes a centralized market mechanism to replace the Clean Development Mechanism (CDM), supporting sustainable development and encouraging nations to adopt more ambitious climate targets.
What is Carbon Trading?
Carbon trading, also known as emissions trading, is a market-based mechanism aimed at reducing greenhouse gas (GHG) emissions. The concept revolves around setting a cap on emissions and allowing entities to buy and sell emission allowances or credits. There are two primary forms of carbon trading: cap-and-trade systems and offset markets.
In cap-and-trade systems, governments set an overall limit (cap) on emissions. Companies receive or buy permits (allowances) to emit up to a certain level and can trade unused allowances. Offset markets, on the other hand, enable entities to invest in projects that reduce or absorb emissions, such as afforestation or renewable energy projects, and earn carbon credits that can be sold to offset their emissions.
Origins and Evolution of Carbon Trading
The idea of carbon trading emerged from economic theories advocating market-based solutions to environmental issues. Its formal genesis began with the economic theories of the 1960s and 1970s, when economists like Ronald Coase theorized about pricing externalities (e.g., pollution) to encourage sustainable practices.
The Kyoto Protocol of 1997 was a watershed moment in the institutionalization of carbon markets, introducing mechanisms like the Clean Development Mechanism (CDM) and Joint Implementation (JI) to allow countries to trade emissions and meet reduction targets. Since then, carbon trading has evolved significantly. The European Union Emissions Trading System (EU ETS), launched in 2005, became a model for cap-and-trade systems, inspiring similar initiatives worldwide. The Paris Agreement in 2015 further emphasized national commitments (Nationally Determined Contributions, or NDCs) and established Article 6, outlining guidelines for international carbon markets. Voluntary Carbon Markets (VCMs) also emerged, reflecting growing private sector interest.
Carbon Trading: Promises and Challenges
The operationalization of Article 6 of the Paris Agreement following the Baku Agreement has brought carbon trading to the forefront of global climate action. While this mechanism has several promising aspects, it also presents significant challenges.
Carbon trading offers cost-effectiveness by ensuring that reductions occur where they are most economically viable, encouraging innovation and fostering investments in cleaner technologies. It facilitates global collaboration, transferring funds and technologies to developing nations, and supports sustainable development by financing resource-rich projects in developing countries.
However, challenges like market volatility, weak caps, and excess allowances undermine the system’s effectiveness. Fluctuating prices of carbon credits create uncertainty for investors and stakeholders and issues like the “hot air” phenomenon observed during the early phases of the EU -ETS undermine the system’s effectiveness. Double counting and leakages pose serious threats to the system’s integrity, while ethical concerns argue that carbon trading commodifies nature, allowing wealthier nations to bypass their responsibilities by purchasing credits.