Since the establishment of the first global agreement to limit greenhouse gas emissions – the Kyoto Protocol – the idea of trading in emissions units, or emissions reduction, has been an essential part of the architecture, motivated by calculations showing that costs of emissions mitigation vary widely among countries. So why not exploit the more cost-efficient mitigation options first if the intended effect on the atmosphere is the same?
With the idea of emissions trading under the Kyoto Protocol came a Pandora’s Box of complexities that has attracted so much attention and debate that it is tempting to believe that the global response to climate change is first and foremost about the trading. But in terms of GHG emissions reduction, trading is essentially a zero-sum game as long as it does not lead to a strengthening of emissions targets. It ensures ‘where-flexibility’ of emissions reduction actions, leaving the trading parties relatively better off economically, but is not designed to reduce a single ton of carbon emissions, unless a level of compulsory retirement without crediting is stipulated. Therefore, the negotiators of international carbon markets under Article 6 of the Paris Agreement specified that Article 6 should lead to an increase in global mitigation ambition. In practice, however, such causality may be hard to prove.
This paper presents a possible solution to one of the most crucial, but surprisingly less recognized, challenges to project-based emissions trading. Emissions reductions are achieved through operation of installations or assets with lower emissions than their baseline or business as usual alternative. Thus, revenues from emission credits are a future cash flow contingent upon project owners’ ability to finance the investment – which has been a persistent challenge ever since international emission credit markets were set up in the late 1990s. It has been baptised ‘results-based financing’, but unless there are mechanisms to transform future cash-flows into present capital, results-based financing is a contradiction in terms.
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