This is the third article in a six-part series examining how carbon markets can catalyze the transition to a green economy. Previous articles in this series describe reimagining carbon markets and a new model for additionality.
One of the biggest challenges facing carbon markets is ensuring long-term transitions for project types that lack an underlying economic rationale to sustain themselves without carbon finance. Put simply, without a non-carbon source of revenue, these projects could end up shutting down once they can no longer issue carbon credits.
Rethinking government’s role
Some projects developed with carbon finance, such as those that destroy industrial gases, are highly additional because without carbon finance they simply do not get implemented. However, unless we figure out how to ensure they continue operating in the long run, beyond the end of their crediting period, these projects are not likely to play a role in the green transition. One obvious solution lies in government intervention.
There are several reasons to rethink the role of governments in carbon markets:
- Increasing pressure to act: The landscape for government action on climate change and carbon markets has changed drastically. Whereas the Kyoto Protocol had a top-down approach and did not impose targets on all countries, the Paris Agreement’s bottom-up approach requires all governments to act. Additionally, agreements such as the 2030 Targets under the Convention on Biological Diversity pressure governments to deliver tangible actions to protect and restore natural landscapes, which can be accomplished through thoughtful carbon management.
- Endgame considerations: Not all projects will be able to stand on their own once carbon finance ends. Projects dependent on carbon finance for operational costs often face shutdowns when carbon financing dries up.
- Enforcement is key: While carbon finance can provide resources for important activities, government enforcement is essential for addressing illegal activities, many of which generate significant sources of emissions (illegal mining and timber operations). Governments are also uniquely qualified to design, implement and enforce regulations that limit or reduce greenhouse gases (GHGs).
Carbon markets can help — but only if structured properly
Calling on governments to act on climate is challenging, especially for developing countries that face the daunting task of increasing climate ambition while supporting basic needs with limited resources. This challenge is only exacerbated by the severe impacts of climate change they did not cause.
Carbon markets can help governments overcome key challenges in setting and meeting ambitious targets. I believe a model worth exploring entails governments committing to regulate GHG emissions in certain sectors of their economy in the future in exchange for investments through carbon markets today. This approach could address some key challenges governments face in regulating GHGs:
- Reducing costs: Carbon finance can help introduce new climate-friendly technologies and practices, reducing costs and building local capacity. Early investments through carbon markets could therefore lower future costs for governments by funding new equipment and training, thereby setting the stage for future government action that will not be as costly.
- Political cover: Imposing GHG regulations is politically challenging. A well-structured approach that allows governments to reap short-term benefits (foreign direct investment, jobs, economic development, environmental protection) while committing to future climate action can establish a powerful formula for tackling this challenge.
Funding shortfalls and regulatory challenges of the Paris Agreement
Despite its success, the Paris Agreement has limitations. Unfortunately, not all promised funding has been delivered, and public funding takes time to translate into action. The trading framework under Article 6, which establishes cooperative approaches for countries to pursue climate targets, also presents challenges. In particular, the requirement that host countries make “corresponding adjustments” for each metric ton of carbon traded means they will seek to have enough headroom in their baseline, which discourages them from taking on more ambitious targets.
Government commitments to ensure project longevity would enable governments to structure investment frameworks in their economies and help integrate project investments into broader development strategies. For natural climate solutions, such commitments could address concerns around permanence, which in turn would reduce project risk and result in lower buffer contributions, thereby strengthening project finances.
Governments could generate immediate benefits (technology, jobs) while building capacity and institutions for long-term regulation. This could help bridge the funding gap in climate finance pledges, incentivize support for carbon projects backed by governments, and provide transparency through a public registry of government commitments and milestones.
Driving economic transition and investment
Commitments made by governments to regulate sectors once there is no more carbon finance would benefit both compliance and voluntary carbon market projects and support the green transition. While such commitments would be critical for projects that do not have an underlying economic rationale, they would help accelerate the transition for project types that can generate revenues on their own by providing strong signals to the market and fostering a welcoming investment climate.
While implementing these ideas will be challenging, forward-looking governments can leverage carbon markets to transition specific parts of their economies, including the industrial or forest sectors, and thus improve the lives of their populations. Such an approach could create a “race to the top,” with leading countries — the ones setting out commitments to regulate certain industries — likely to attract investments into crucial sectors they wish to address but currently lack the resources or expertise to support.
David Antonioli is a net-zero transition consultant and was the founding CEO of Verra until June 2023. The topic of government participation in carbon markets is addressed in greater detail in Chapter 3 of his recently released report Financing the Transitions the World Needs; Towards a New Paradigm for Carbon Markets.