Will Kerry’s COP27 initiative drive EMDE energy transition and put voluntary carbon markets on the fast track to credibility?
Mobilising public and private capital to fund the net zero transition efforts of emerging markets and developing economies (EMDEs) has been a central theme of discussions at COP27 in Egypt.
UN Secretary-General António Guterres opened the summit emphasising that EMDEs are “critical to bending the global emissions curve”, calling for developed and emerging economies to form a Climate Solidarity Pact, through which wealthier countries and international financial institutions will provide technical and financial support to EMDEs transitioning to clean energy.
Annual clean energy investment in EMDEs needs to increase by more than seven times, from US$150 billion in 2020 to over US$1 trillion a year by 2030, according to an International Energy Agency (IEA) report.
Discussions on climate finance will continue in Sharm El Sheikh, but developed countries have since launched individual initiatives to support EMDEs.
One of the most notable was announced by US Special Presidential Envoy for Climate John Kerry on COP27’s Finance Day. The Energy Transition Accelerator (ETA) – a scheme which utilises voluntary carbon markets (VCMs) – aims to finance the decommissioning of coal-fired power and the deployment of clean energy across EMDEs through the sale of carbon credits until 2030. It has been launched in partnership with philanthropies the Bezos Earth Fund and Rockefeller Foundation.
“There is only one way we’re going to keep 1.5°C alive and that is if we bring the private sector to the table and unleash literally trillions of dollars of investment into the developing world,” said Kerry.
VCMs have logged rapid growth in recent years, reaching nearly US$2 billion by the end of 2021, and expected to reach US$50 billion by 2030. They work by facilitating the trading of carbon credits that don’t count towards mandatory decarbonisation targets or fall under regulated carbon markets.
In theory, a VCM is an innovative way to raise the capital needed to support clean energy transition across EMDEs, but there are a number of questions about how the ETA will work in practice. And there are wider issues around the VCMs already in operation, such as credit pricing, third-party verification and reducing the risk of greenwashing.
The ETA is “not fully baked yet”, Kerry admitted, but there are plans for it to be up and running by COP28 in Dubai.
This explainer will explore the blueprint for the US ETA and consider the role of VCMs is channelling finance from developed markets to EMDEs.
How will the ETA work?
The ETA will create a new class of carbon offsets that either represent investments in EMDE renewable energy projects or converted reductions in emissions from the power sector (such as coal-fired electricity). Participating jurisdictions can sell these credits to companies looking to offset a portion of their own carbon emissions, with a percentage of the revenue generated also being mobilised to support climate adaptation and resilience in the most climate-vulnerable EMDEs.
The idea is that providing jurisdictions with fixed-price advance purchase commitments for these offsets will secure an established and consistent finance stream that can then unlock more private finance at favourable rates.
The idea to utilise voluntary markets is “a good one”, as it’s “part of the principle of ‘cooperative action’ enshrined in the Paris Agreement,” Guy Turner, CEO of specialist data, analysis and advisory firm Trove Research, tells ESG Investor.
“It makes sense for countries where it is costly to reduce emissions to pay for the emissions reductions where it is cheaper to do so.”
In an optimistic scenario, assuming a carbon price of US$30 per tonne, climate policy consultancy firm Climate Advisers estimated that the ETA could mobilise between US$77-US$139 billion by 2030, mitigating 1.3-2.3 billion tonnes of CO2 and further generating US$3.8-US$6.9 billion in international climate adaptation investments. A more modest scenario – in which the ETA will operate at the scale of current public-private partnerships efforts to finance climate action in EMDEs – would raise US$4-8 billion, mitigate 64-128 million tonnes of CO2 by 2030, and generate US$200-400 million for international adaptation.
Kerry has promised “strong safeguards”, noting that companies must have net zero goals and science-based interim targets to be eligible for these credits.
“And they must use these credits to supplement, not substitute for, deep reductions in their own emissions,” he said.
The ETA will also introduce transparency requirements and specify how companies’ investments in these credits will be recognised. It remains to be seen whether companies will be allowed to use the credits to support climate mitigation beyond their interim targets or use them to cover a limited portion of their near-term Scope 3 emissions reductions targets. If the latter, companies would be required to “pay for additional credits solely to magnify the ETA’s financial and climate benefits”, according to a statement on the launch.
Fossil fuel companies will not be allowed to participate in the programme.
To ensure a just transition, the ETA will also establish social safeguards and benefits to local economies, such as supporting job creation and training.
Kerry said: “We believe this can be catalytic: By ensuring a predictable finance stream for energy transition, this approach will increase the bankability of clean energy projects, and unlock more concessionary, upfront finance.”
How urgent is the need the ETA is seeking to fill?
While Kerry’s method may have raised some eyebrows, his target did not. The failure of rich nations to make good on their pledge to supply US$100 billion annually in climate finance is a long-running bone of contention for the countries most threatened by climate change and is a key focus at COP27.
And a report released in Sharm El Sheikh by the Independent High-Level Expert Group on Climate Finance said the overall cost of supporting climate action in developing countries could rise to US$2.4 trillion by 2030, to boost resilience and deal with the loss and damage caused by climate change impacts.
But the ETA is focused in particular on supporting climate mitigation in EMDEs, supporting the transition to renewable energy sources and weaning countries off coal power, the most carbon-intensive of fossil fuels, as soon as possible. The need is widespread geographically, but far from universal. In Africa for example, the need is keenest in heavily industrialised countries like South Africa, while Indonesia, Vietnam, the Philippines and a number of Latin American countries are also intensive users of coal.
In a new report, the IEA outlined the challenges of retiring the 9,000 coal-fired plants currently in operation globally, warning that their emissions alone would be enough to take the world past 1.5°C of climate change.
South Africa was the first country to sign a Just Energy Transition Partnership (JETP) with rich western nations. The deal committed US$8.5 billion of first-phase financing, through mechanisms including grants, concessional loans and investments and risk sharing instruments, but it has taken time for details to be worked out on how funding would be channelled to support decommissioning of soon-to-be-stranded assets.
Indeed, it was only at the World Leaders Summit at COP27 that the International Partners Group (IPG), chaired by the UK and comprised of France, Germany, the UK, the US and the EU, endorsed South Africa’s Just Energy Transition Investment Plan, which includes “highly concessional” funding for decommissioning. A few days earlier, the World Bank approved South Africa’s request for US$497 million to decommission and repurpose the Komati coal-fired power plant using renewables and batteries, a project aligned to the country’s Just Transition Framework.
The South African deal provided the template for the JETP signed this week at the Group of 20 leaders summit in Indonesia. Led by the US and Japan, the IPG has made an initial commitment of US$10 billion over a three-to-five year period to accelerate the phasing down of fossil fuels and ramping up of renewable energy, supporting also the development of transition-aligned jobs and industries. The investment is explicitly intended to stimulate private sector investment and the ETA must play a key role.
The deal is unlikely to be the last in the region. In a recent report, the International Renewable Energy Agency highlighted that the ASEAN member countries were home to a new and cheap fleet of coal-fired power stations, noting that it presented a barrier to renewables transitions.
A separate report by Moody’s further highlighted the challenges of achieving a just transition to renewable energy sources in EMDEs, noting that social, governance and financing risks were typically high, but adding that innovations such as sustainability-linked bonds “can help fill the substantial funding gap between sovereigns’ current budgets and projected transition costs”.
What details are missing from the ETA blueprint?
There are a number of unanswered questions that need to be addressed to instil investors, companies and governments with enough confidence to back the ETA. In particular, there are calls for clarity around the pricing and issuance of credits.
While the ETA will offer a “fixed price” for corporates, there are concerns that too low a price could reduce the quality of the credits and expose the market to greenwashing risk.
Low prices across VCMs are already hotly debated. Prior to COP27, the Democratic Republic of the Congo’s (DRC) President called for a price of US$100 per metric tonne for Congo basin-generated credits, which is far higher than their current average price of US$4-6.
Further, Kerry promised that 5% of the value of the credits will be used to support climate adaptation in EMDEs, but it is unclear whether this means the capital will be invested in an existing vehicle like the Adaptation Fund or elsewhere.
The US has also yet to define the maximum percentage of a company’s emissions ETA credits will cover. The Science Based Targets initiative’s Net Zero Standard and the UN High-Level Expert Group’s guidance both state that high-quality carbon credits should only be used for a small percentage of emissions as a last resort.
“Inducing companies to finance emission reductions remains an attractive idea, but the true barrier remains that companies have only limited incentives and rationales to buy carbon credits,” says Ashur Nissan, Partner at specialist climate policy consultancy Kaya Advisory.
“They receive mixed signals from their stakeholders and regulators on the appropriate role carbon credits play in net zero strategies.”
There is also the question of what the ETA means in terms of the US’ prior pledge to contribute US$11.4 billion in climate finance to EMDEs by 2024, having committed just US$1 billion so far. In the aforementioned COP27 interview, Kerry insisted the full US$11.4 billion will be delivered on schedule.
“Kerry’s proposal reveals how unlikely it is that developed nations, particularly Kerry’s own US, provide sufficient public climate finance. In attempting to promote this private sector transfer, we see an implicit acknowledgement of this and a hope that private firms take up the slack,” says Nissan.
The US State Department, Rockefeller Foundation and Bezos Earth Fund have promised to deliver further guidance and clarity over the next 12 months.
The partners are planning to work on a methodology outlining protocols for crediting, monitoring, reporting and verification, as well as specific rules and safeguards for companies and parameters to maintain integrity and ensure sufficient supply at a jurisdictional level. There will also be guidance for social safeguards and end-to-end transparency.
Are VCMs the best way to raise climate finance for EMDEs?
While there are concrete examples of VCMs making a positive difference across EMDEs, the unfortunate reality is that they are also plagued with opacity and controversy.
“There is a reason that carbon offsets have been associated with greenwashing, which must absolutely be avoided,” said Ani Dasgupta, President and CEO of the World Resources Institute (WRI).
In 2021, Finnish NGO and offset brokerage Compensate analysed 100 offsets certified by voluntary carbon offset programme Gold Standard and other groups, finding that 90% of projects either failed to offset as much as they claimed or actually caused damage to local biodiversity and disrupted local communities.
A more recent investigation found that a major European logging firm had illegally converted more than a dozen of its timber concessions in the DRC into conservation concessions that overlapped with ancestral lands and climate-critical peatlands.
It’s unsurprising, then, that some EMDEs have imposed moratoriums on VCMs until such a point that their governments feel confident they have sufficient oversight to manage future and existing deals. These include Papua New Guinea, Indonesia and Honduras.
India also has plans to launch its own VCM, but it will be limited to domestic trading so that carbon credits can more directly contribute to its nationally determined contribution and domestic entities’ decarbonisation efforts.
Arguably, the US ETA’s objective of accelerating the deployment of renewable energy and decommissioning unabated coal-fired power will be easier to quantify and verify. After all, it’s easier to spot deception if a coal-fired power plant stays in operation compared to attempting to measure whether the number of credits sold by a reforestation project in the Amazon is in line with the percentage of emissions it is actually offsetting.
Of course, VCMs aren’t the only way for public and private sectors to invest in EMDE climate transition efforts.
Another big theme at COP27 has been the importance of upscaling blended finance transactions, which refers to catalytic development finance from the public sector upscaling climate mitigation or adaptation projects or companies to then attract additional capital from private investors.
“If EMDEs see [the ETA] as a substitute for concessional finance, then it is unlikely they will buy into it. Concessional finance and carbon market finance should be complementary, not in competition,” says Nissan.
Is the ETA necessary when EMDEs are coming forward with their own VCMs?
The ETA could potentially inject a huge amount of capital into EMDEs, but some of these countries are putting forward their own VCM blueprints to mobilise the capital they need to transition to clean energy.
“African carbon credits represent a small proportion of the market due to challenges including the lack of project developers capable of operating at scale, the lack of adequate infrastructure for trading, and complex regulatory and political contexts,” says Kaya Advisory’s Nissan.
“The Africa Carbon Markets Initiative (ACMI) is a good step to address these issues in a more systematic way.”
The ACMI was inaugurated at COP27 in collaboration with The Global Energy Alliance for People and Planet (GEAPP), Sustainable Energy for All (SEforALL) and the UN Economic Commission for Africa. It has support from UN Climate Change High-Level Champions Dr Mahmoud Mohieldin and Nigel Topping.
The ACMI plans to annually generate 300 million high-quality carbon credits by 2030, which would unlock US$6 billion in capital and support 30 million jobs. By 2050, this would grow to 1.5 billion credits being produced annually, leveraging over US$120 billion and supporting over 110 billion jobs.
In tandem with the announcement, ACMI published its roadmap report, outlining 13 action programmes that will support the growth of VCMs on the continent. These include scaling up programmes with micro carbon credits generation involving smallholder farmers and identifying long-term, innovative financing models for critical geographic areas.
Kenya, Malawi and Nigeria are among the countries to have agreed to support ACMI’s efforts to upscale the continent’s contributions to voluntary markets.
The ACMI is also working with carbon credit buyers and financiers, such as multinational bank Standard Chartered, to set up advance market commitments of hundreds of millions of dollars for high-integrity African carbon credits.
How can the credibility and effectiveness of the ETA be measured?
The parameters of the ETA can be shaped by carbon markets guidance being developed by international supervisory bodies and regulators.
Discussions around Article 6.4 of the Paris Agreement have continued at COP27, with the supervisory body closing its third meeting on 6 November, the first day of the summit, having finalised its recommendations regarding carbon removals for consideration by the Parties to the Agreement. However, recommendations for methodologies could not be completed during the meeting and will be revisited at a later date.
Article 6.4 is set to provide a framework for a multilateral carbon credits market overseen by the 12-member body that will serve as the centralised global project authorisation system. Approved credits will be given the A6.4ERs label and can be sold to countries, companies and individuals.
Five more meetings are scheduled for 2023, where the supervisory group will continue its efforts to build the market mechanism and facilitate government and private sector participation.
The International Organization of Securities Commissions (IOSCO) has also weighed in, publishing a discussion paper to help advance the conversation around what constitutes an efficient VCM and what role financial regulators may play in ensuring market integrity.
Alongside concerns around credit quality, leakage of carbon and transparency, IOSCO has identified the lack of standardised documentation for carbon credits as a barrier to scaling VCMs – an issue the ETA will also need to consider. Standardisation can “help create liquidity and depth in financial markets”, IOSCO said.
The organisation has flagged whether it should work more closely with the Integrity Council for the Voluntary Carbon Market (ICVCM) and Voluntary Carbon Markets Integrity Initiative (VCMI), and what that collaboration may look like.
The ICVCM works on the supply side of carbon credit generation and establishment of offsetting projects, developing Core Carbon Principles (CCPs) that set threshold standards for what constitutes a high-quality carbon credit and which existing third-party verification systems are “CCP-eligible”. The final CCPs and an accompanying assessment framework will be published by the end of this year.
Adjacently, the VCMI is introducing demand-side rules for companies that intend to use carbon credits to offset a portion of their emissions. Its draft claims code of practice was published in June to help investors and other actors scrutinise companies’ carbon credit claims through gold, silver and bronze markers. A company with a gold marker has demonstrated that it is closely aligned to VCMI guidance. A next version of the code will be published early 2023.
Following the launch of Kerry’s ETA, VCMI Co-Chair Rachel Kyte told the Financial Times that the proposal was a “massive distraction” from existing efforts to bring order to voluntary markets.
“There has been an extraordinary effort to build the rules [of the carbon credit market]. You can’t shortcut that,” she said.