In Brief:
- Explore the fundamental concepts of carbon credits, including their role in reducing greenhouse gas emissions and the types of projects that generate these credits.
- Gain insights into the international and local legal frameworks that govern carbon credits, including the Kyoto Protocol, the Paris Agreement, and the UAE's regulations.
- Learn the key considerations for drafting Emissions Reduction Purchase Agreements (ERPAs), ensuring compliance with legal standards and the successful execution of carbon credit transactions.
Shaping a Sustainable Future: A brief overview of Carbon Credits and its Legal Framework
Carbon credits have emerged as an important tool in international efforts to combat the harmful effects of greenhouse gas emissions ("GHG") by providing a financial incentive for initiatives focused on reducing such emissions. This article aims to provide a brief overview of carbon credits, including their regulatory framework while highlighting essential considerations in drafting effective carbon credit contracts.
Commonly referred to as carbon offsets, carbon credits essentially function as permits allowing the release of predetermined quantities of carbon dioxide and other GHG into the atmosphere. Each credit represents a measurable reduction or removal of emissions, often equivalent to one metric ton of carbon dioxide and other GHG. When a project receives verification that it has reduced the amount of GHG produced or avoided producing or destroying one metric ton of GHG, one carbon offset is created; such projects can then sell or transfer the offsets to entities and countries that cannot meet their GHG emission reduction goals or limits. Examples of carbon credit generating projects include renewable energy facilities, wind and solar farms, and other projects that capture methane emissions from landfills, livestock farming, and oil and gas operations.
The concept of carbon credits originates in the United Nations Framework Convention on Climate Change and the Kyoto Protocol. Articles 12 and 17 of the Protocol, among other things, introduce the concept of a cap-and-trade system and the Clean Development Mechanism ("CDM") system, whereby Annex (1) countries (developed countries) agreed to reduce their GHG emissions to specific levels ("caps") and were allowed to satisfy such caps by either reducing emissions in their own countries, or by implementing GHG emission-reducing projects in developing countries, or trading. Credits acquired are included in the GHG emissions reduction targets of the relevant developed country.
The Paris Agreement is another essential instrument in this regard. Article 6 of the Paris Agreement establishes guidelines for cooperation among countries to achieve their GHG emission reduction goals pursuant to the "Nationally Determined Contributions" ("NDC") framework. The Agreement allows countries to transfer credits earned from reducing GHG emissions to other counties to help them meet NDC goals while avoiding any double counting of credits towards NDC goals.
In the United Arab Emirates ("UAE"), the legal framework for carbon credit contracts encompasses a number of international agreements to which the UAE is a signatory, together with local laws and regulations. The UAE has ratified each of the United Nations Framework Convention on Climate Change, the Kyoto Protocol and the Paris Agreement.
It is important to note that carbon trading can occur in both compliance and voluntary contexts.
In Compliance Carbon Markets ("CCM"), carbon trading occurs within a defined regulatory framework. Such frameworks are typically based on mandatory domestic, regional, and international GHG reduction obligations that are implemented by the relevant government bodies. Governments in these markets establish mandatory emission reduction targets for specific sectors, industries, or entities and provide a legal framework for meeting targets through emission allowance trading. The primary tradable units within CCMs are emission allowances. Entities operating within CCM can sell, purchase, and trade emission allowances, thereby meeting their emission reduction obligations. In cases where entities have successfully implemented emission reduction mechanisms leading to excess allowances, they can transfer or sell these allowances to other entities that cannot meet their goals.
In a Voluntary Carbon Market ("VCM"), companies and businesses, driven by various factors, including corporate social responsibility and sustainability goals, voluntarily offset their carbon emissions, thereby creating carbon offsets, which they can then trade. As indicated by its name, a VCM operate outside mandatory regulatory frameworks that necessitate reduction in carbon emissions and rely predominantly on carbon-offset projects to generate carbon credits. While largely supplementary to the compliance market, according to some observers, the global value of VCM is predicted to increase to between $10 billion and $40 billion by 2030.
VCM relies on independent verification and certification of relevant projects to ensure transparency and maintain the confidence of buyers in the claimed reduction or removal of GHG emissions. Certifying bodies include the Voluntary Gold Standard, operated by the Gold Standard Foundation, which is designed to ensure that the carbon credits are real and verifiable.
The implementation of carbon credit and emission trading requires the establishment of appropriate legal agreements and documentation. Most significant of such agreements is the Emissions Reduction Purchase Agreement ("ERPA").
In drafting an ERPA, it is imperative to have sufficient knowledge of the legal framework governing such agreements within the relevant jurisdiction, in addition to understanding the relevant international standards that should be incorporated into the ERPA. The ERPA should clarify, among other things, the nature of the project involved and how it will be developed, the quantity and price of emissions to be delivered (the pricing mechanism), the delivery and payment schedule, and the consequence of non-delivery and payment default. It should specify the general responsibilities of the parties, including the fulfillment of the verification and certification process of the project, determining the verifying authority or standard, identifying project risks, and assigning responsibilities.
Carbon credits continue to play an important role as the world continues to progress towards a more environmentally conscious future. By leveraging the power of market-based mechanisms, carbon credit has potential to drive transformative change, aiding in the attainment of a more sustainable and resilient planet.
Originally Published 8 July 2024
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.