In just under a month, the UN Climate Change Conference will begin in Glasgow, Scotland, heralding the 26th Conference of the Parties (COP26).  For well over two decades, the UN has brought together nearly 200 countries for the climate conference, representing every geographic area on Earth.  In that time, climate change has moved from a fringe issue to one of the most pressing global challenges in recent human history.

In the lead up to COP26, the UK and Italy, as co-hosts, are working with nations to reach agreement on how to tackle climate change through international collaboration and standards.  COP26 will focus on agreeing changes to countries’ existing emissions reduction targets, climate change adaptation, climate action funding and international collaboration.  However, most experts believe that COP26 has a unique urgency, given the increasingly dire outlook for the Earth’s climate.  The Sixth Assessment Report by the Intergovernmental Panel on Climate Change (IPCC Report) has only added fire to the flames, finding that Earth could well exceed warming of 1.5 degrees Celsius by the early 2030s.  Countries are also coming under pressure from within, with climate change-related litigation and investor activism gathering pace around the globe.  Societies are beginning to demand real change, and COP26 has the ability to bring countries together on key climate change mitigation initiatives and act as a catalyst for that change.

In this article, we set out two key issues that will be addressed at COP26 that are relevant to Australia’s efforts to lower emissions: the promise of Article 6 in creating international cooperation in the quest for net zero emissions and the problems posed by increasing scrutiny of coal-fired power generation.

Key takeaways 

  • There is hope that COP26 is the conference that finally resolves the long-standing issues with Article 6. The key challenge ahead is for all countries to agree on the rules and processes for the three emissions reduction mechanisms envisaged under Article 6. The international carbon market under Article 6 is the mechanism most likely to have an immediate effect on Australian companies, as it will allow companies to trade “internationally traded mitigation outcomes” (ITMOs) on an international scale. 
  • Coal will be in the spotlight at COP26. Coal-generated power and the move away from it has been a sticking point for international negotiations in the lead-up to COP26. It is possible that the coal supply chain, from producers to suppliers and power station owners, will buckle as international pressure builds to move away from coal, leaving the Australian coal industry at risk of being left with stranded assets and limited offtake options. However, we do not expect this risk to eventuate for some time, given the current high levels of reliance on coal both domestically and internationally.

What to watch at COP26 

There are two issues to be discussed at COP26 that will directly affect Australia:

  • Emissions reduction activities and trading schemes under Article 6 of the Paris Agreement: Article 6 establishes three mechanisms for the mitigation of greenhouse gas emissions, covering concepts from trading schemes through to direct investment in emissions reduction activities.  This lays the basis for a global emissions trading exchange in which Australian companies could participate.
  • The future of coal as a source of power generation. There is growing international pressure for countries to move away from coal reliance in generating power.  This poses challenges for Australia given it primarily relies on coal for energy production.

Emissions reduction mechanisms under Article 6 of COP26

Perhaps the most significant item up for discussion on the COP26 agenda is the status of Article 6 of the Paris Agreement.  Article 6 was a surprise inclusion in the Paris Agreement, as progress on an international carbon market had been stagnant up until that point.  Its inclusion at COP21 gave delegates a sense of hope and achievement.  However, there has been a conspicuous lack of agreement on the rules that would render Article 6 operational.  Those rules were supposed to be agreed on and adopted at COP24 in Katowice, Poland, but this did not occur.  Since then, parties have moved further away from any agreement.  Given the climate emergency facing the planet, COP26 is seen as a final opportunity to nail down the rules. 

Article 6 envisages three mechanisms for the transfer of so-called ITMOs between countries, companies and other international actors.  ITMOs essentially refer to greenhouse gas emissions reduction activities, in which the reduction outcomes can be transferred (for example, by way of trading) to help other entities reduce their emissions.  ITMOs are conceptually wide, accounting for a diverse range of activities such as carbon markets, renewable energy capacity or re-forestation initiatives.

The three voluntary mechanisms envisaged by Article 6 are:

  • A State-level trading mechanism, allowing a country that is beating its internationally recognised commitment to reduce greenhouse gas emissions (known as “nationally determined contributions” or NDCs) to sell its overachievements to a country that is failing to meet its NDC.  The exact nature of the ITMOs to be transferred is still to be decided.  
  • An international carbon market, governed by a UN body, through which private and public entities may trade emissions reductions across the globe.  An example of this is the trading of carbon credits to offset emissions from air travel, as is currently the case with the International Civil Aviation Authority’s CORSIA scheme.  This Article 6 mechanism is the only one that requires demonstrating an “overall mitigation in global emissions”, meaning that greenhouse gas emissions must fall not merely because of other emissions reduction mechanisms, as these reductions would have occurred in spite of the international carbon market. 
  • A non-market (ie non-trading) mechanism for climate cooperation between States, such as State investment (in, for instance, a new windfarm), development aid or concessional loans.  Switzerland has entered into bilateral agreements with Peru, Ghana, Senegal and Vanuatu under which it will develop climate protection projects in those countries.  The emissions reductions achieved by those projects will be attributed to Switzerland.  Additionally, Sweden is seeking to implement bilateral agreements for decarbonised projects in Ghana and the Dominican Republic.  In Sweden’s case, the country is seeking specifically for these projects to be recognized as ITMOs under Article 6, suggesting that it intends to put pressure on countries to come to an agreement on Article 6 rules.

The key challenge ahead is for all countries to agree on the rules and processes for the three mechanisms, which will require intense scrutiny of loopholes to ensure emissions reductions are not counted twice and that an overall reduction in greenhouse gases is actually achieved.

COP26 also provides an opportunity to hold countries accountable to their NDCs.  NDCs enable countries to set their own targets, which will be revised under the so-called “ratchet mechanism” every five years.  In this way, the world does not need to develop a final plan to combat climate change; countries are merely being asked to build on their ambitions over successive five-year periods.  Even if the rules of Article 6 remain elusive, the NDC mechanism should provide a means of measuring COP26’s success.  Having said this, the UN secretary-general, António Guterres, is concerned that countries will fail to abide by, or contribute to, the NDC mechanism.  Currently, it appears the most effective action on climate change is arising from bilateral agreements, given the recent announcement of a joint US-EU effort to curb methane emissions, the so-called Global Methane Pledge.  Other countries are able to commit to the pledge, but it remains to be seen whether Australia will sign up.

The future of coal

Boris Johnson, the UK prime minister, recently shone a spotlight on the use of coal-fired power stations, arguing their use needs to end in all countries in order to limit global warming to within 1.5 degrees Celsius.  The role of coal in the near future is proving difficult to manage.  Many countries are reliant on coal-generated power and the move away from it has been a sticking point for international negotiations in the lead up to COP26.  A recent meeting of the G20 in Naples was unable to reach agreement on moving away from coal power, with India being one of the strongest opposers.  The world’s largest emitter, China, is under increasing scrutiny to cut its carbon emissions, while its coal consumption reaches record highs.  Developed countries are also resisting the call to axe coal: US President Joe Biden refused to commit himself to ending domestic coal power in a G7 meeting in June 2021. 

In Australia, coal is the primary source of electricity generation and produces around 80% of the country’s electricity requirements.  This is a staggering percentage, particularly given the rapid uptake of wind and solar farms, in which Australia has outperformed much of the world.  But the Federal government faces significant pressure from certain coal-heavy areas in central Queensland, the Hunter Valley in NSW, Victoria’s Latrobe Valley, and Western Australia and has steered clear of making any promises to reduce coal consumption.  Australia is therefore unlikely to support any direct requirement to reduce the use of coal except, perhaps, to the extent that such a requirement relates to its interactions with other countries (for instance, agreeing not to provide finance for coal-fired power stations overseas).  Despite this, the NSW energy minister recently announced that ending coal-fired power stations by 2030 was more than achievable.  However, the commitment to the Paris Agreement targets at Federal level appears weak: bowing to Australian pressure, the UK recently agreed to remove a reference to the temperature targets of the Paris Agreement from the text of a free trade deal being negotiated between the two countries. 

The outcomes of COP26: why they matter to you and your business

The outcomes from COP26 relating to Article 6 and the issue of coal will have real-world impacts, including shaping Australia’s quest for net zero emissions

In terms of the private sector, the international carbon market under Article 6 is the mechanism most likely to have an immediate effect on Australian companies, as it will allow companies to trade ITMOs on an international scale.  Currently, Australia has a similar scheme, the Emissions Reduction Fund, through which companies can earn Australian carbon credit units (ACCUs).  These can be sold either to the government or on a secondary market for other companies to offset their emissions.  This is an example of an ITMO trading mechanism, to which the international market would add another dimension: companies could choose to trade ITMOs (in a similar form, perhaps, to ACCUs) internationally, giving them greater flexibility to tackle climate change on a truly global scale.  The Clean Energy Regulator recently put out expressions of interest regarding the establishment of an Australian carbon exchange to simplify ACCU trading.  Such an exchange could potentially be tied into a similar mechanism at the international level.

As for coal, it is entirely possible that the coal supply chain, from producers to suppliers and power station owners, will buckle as international pressure builds to move away from coal.  Companies run the real risk of being left with stranded assets and coal-reliant regions will become exposed to economic ruin without appropriate initiatives from State and Federal governments.  However, we do not expect this risk to eventuate for some time, given the current high levels of reliance on coal both domestically and internationally.  The top importers of Australian coal are Japan, China and India, with Japan being the only country of the three showing signs of a shift away from coal, as lending from financial institutions and government tightens for carbon-intensive projects.  

Why COP26 is an opportunity 

COP26 provides an opportunity for the world’s leaders to resolve pressing issues in the fight against climate change and the quest for net zero emissions.  Tacking climate change requires positive action; not just lip-service and optimism. Above all, COP26 is another chance to instigate positive action. However, despite the summit’s imminence, the silence from the leaders of some of the world’s biggest emitters in relation to the IPCC Report and COP26 commitments does not bode well.  However, if countries are able to put their differences aside and bring their minds to bear on the subject matter at hand, they may just be able to develop innovative and effective measures in the fight to limit climate change. 

The world will be watching the international stage during COP26 and we will be providing an update on the outcomes of the conference in its wake. We remain hopeful that our Federal government will release a substantive long-term strategy for emissions reduction in Australia before COP26 – or run the risk of further global scrutiny as the laggards down under.