Plan for international credits in EU carbon market could boost climate diplomacy

The European Union’s plan to use international carbon credits to ease pressure on domestic decarbonisation under its Emissions Trading System (ETS) could boost global climate action and offer new climate diplomacy opportunities for the EU, government officials and researchers have said. 

“The reform is an opportunity to bring sources of finance into countries that have a harder time ramping up climate policies and climate ambition,” Darius Sultani, a doctoral researcher at the Potsdam Institute for Climate Impact Research (PIK), told Clean Energy Wire.

The EU ETS is currently the world´s biggest carbon market. It follows the polluter pays principle, with the goal of reducing overall EU emissions and generating revenue to finance the energy transition. The system sets a cap on how much CO2 can be emitted, which decreases each year. The ETS covers emissions from the energy sector, industrial manufacturing, and parts of aviation and shipping. A new emissions trading system, ETS 2, will target the transport and building sectors. 

As part of a wide-reaching reform of the ETS, the EU looks set to bring international carbon credits back into what is arguably its most important climate policy instrument. The European Commission has proposed that the EU should buy up to 260 million high-quality international credits between 2036 and 2040. The reform is mainly aimed at easing the pressure on domestic emission reductions. 

Industry businesses have said that they need more time to decarbonise, and that the current emissions trading framework would mean that there would be too little funding for the necessary investments. In addition, the Commission has argued that the purchasing of international credits would also help finance climate action abroad.

Tirivanhu Muhwati, deputy director of the Carbon Markets authority at Zimbabwe’s environmental ministry, welcomed the proposed reform. “The international carbon market needs to be driven by demand, and the EU is the biggest source of that demand,” he said. 

Zimbabwe is seeking to benefit from international credits. The country has prior experience with voluntary carbon markets, but issues with the validity and quality of the credits – as well as whether local communities benefited from the project – have hampered the development of carbon trading. Muhwati believes progress in formalising emissions trading means Zimbabwe is well-positioned to benefit from the ETS reform. 

An international credit represents a tonne of CO2 reduced or removed from the atmosphere through emission reduction projects, such as restoring wetlands or improving energy efficiency. These credits can be traded on carbon markets and allow countries or businesses to achieve voluntary or binding climate targets, even when their own emission reduction efforts lag behind. 

The ETS reform follows the EU’s adoption of its 2040 climate target earlier this year, aiming to reduce net emissions by 90 percent compared to 1990 levels. Up to five percent of those reductions could come from international credits; a share of that would now be integrated into the emissions trading system. The European Commission has not proposed direct integration, under which European companies would buy international credits and submit them in the ETS for every tonne of CO2 they emit. Instead, the EU would set up a financing mechanism to centrally purchase the credits, while increasing the total number of emissions allowances in the system by the corresponding amount. According to the Commission’s assumptions, domestic industry would then have more allowances available at lower prices.

PIK researcher Sultani said the proposed reform has mainly been driven by domestic political and economic interests: “There were a lot of industrial actors who went public complaining about the system being too strict because the investment conditions for them were not ready yet.” 

However, Europe also sees the ETS reform as an additional policy instrument to spur climate action globally, Sultani added. Five years ago, the Commission introduced the Carbon Border Adjustment Mechanism (CBAM), which tariffs carbon-intensive goods imported into the EU. The mechanism was mainly meant to prevent carbon leakage, but the EU has also framed it as a tool to promote cleaner industrial practices in partner countries. 

Five years on, the instrument has been successful in prompting other actors to introduce carbon pricing schemes, Sultani said. Now, “researchers on emissions trading see international credits as an additional opportunity to enhance carbon pricing diplomacy.”

Integration into the ETS signals that the EU is getting more serious about international credits and procuring them on a larger scale, he added: “And that doesn't only create markets, it also creates the global incentives to install monitoring, reporting, and verification, and to build institutions that maintain these markets.”

At the press conference presenting the reform proposal, European Commission executive vice-president Teresa Ribera also highlighted the climate diplomacy angle. The use of international credits “could help reinforce the architecture of the Paris Agreement and send a message of cooperation to our international partners,” she said.

The CBAM has long been a contentious issue for African countries, who have argued that it does not comply with the World Trade Organisation’s (WTO) non-discrimination policy and negatively impacts African exporters – a claim the EU has rejected. 

For Sultani, there are lessons to be learned from the implementation of the CBAM. There was significant resistance from the Global South for several reasons, including the lack of institutional capacity to comply with complex rules. The EU did not recognise this and also failed to engage with those countries in the process of establishing the instrument. “And it backfired,” he said.

For Zimbabwe’s Muhwati, strategic engagement with partner countries is key to avoiding friction. Before implementation of the ETS reforms, there should be ample technical and political consultations between the EU and affected countries. “Consideration of regional principles – such as the African Principles for Integrity and Equity on Carbon Markets – can assist in contextualising carbon market engagement by the EU with the continent [of Africa],” he said.

Despite concerns, the outlook is largely optimistic. Sultani said that the EU will likely pass the proposal with only minor adjustments, and that the reform could help cut emissions by attaching real monetary incentives – rather than voluntary ones – to international climate action. “It depends a lot on how the European Union is going to engage with partner countries, and how in the end this endeavour is going to be perceived,” he said. 

For countries that supply carbon credits, it could mark a new chapter in cooperation between the Global North and South and global climate action. “Participation in the ETS will improve international cooperation,” Muhwati said. “This is an opportunity for peer-to-peer learning and ensuring that the relationship with the EU gets stronger.” 

The EU reform would be part of efforts to develop global carbon markets and projects under Article 6 of the Paris Agreement. The provision allows the possibility for countries to buy and sell credits to each other and use them towards their national climate targets. However, uptake of carbon trading has been slow. The finalisation of the rulebook of Article 6 at the UN climate change conference COP29 in Baku in 2024 could eventually change that. For the Global South, it’s a chance to mobilise sources of climate finance to support the implementation of Nationally Determined Contributions (NDCs) and National Adaptation Plans (NAPs). 

“Zimbabwe is ready to supply international credits under the ETS, as our 2025 Carbon Trading Regulations are clear and aligned with Article 6 of the Paris Agreement,” said government official Muhwati. A Climate Change Management Bill would formally bring activities related to carbon credits under governmental control and regulation. It would also establish the Zimbabwe Carbon Markets Authority, responsible for implementing carbon credit trading regulations and establishing and maintaining the Zimbabwe Carbon Credit Registry – as well as linking it to international registries. 

Muhwati sees numerous benefits in the proposed ETS reform. “The opening up by the EU will create additional demand, strengthen pricing regimes for good quality credits as well as improving the outlook for carbon project developers,” he said. “We see opportunities to advance our green industrialisation and sustainable socio-economic development.”

Some countries are also taking a collective approach, through initiatives such as the Africa Carbon Markets Initiative, the Eastern Africa Alliance on Carbon Markets and Climate Finance (EAACMCF) and Africa Action Plan on Carbon Markets. 

Launched in April this year, the Southern Africa Alliance on Carbon Markets and Climate Finance is the newest carbon market bloc. 

“We want to ensure that Southern Africa effectively participates in the global carbon market and to prevent a race to the bottom,” said Muhwati, who is also serving as the alliance’s interim coordinator. “We´re selling a product, and we want to make sure that the price is right.” 

For the eight countries in the Alliance, international carbon trading has largely happened through the voluntary carbon market, dominated by the private sector with little governmental oversight. The ETS proposal opens the door for bilateral cooperation and intergovernmental agreements. 

For its 2040 climate target, the EU allows up to five percent of the emission reductions to be covered by international carbon credits. Only two percentage points will be part of the ETS under the proposed reforms, with the remaining three available to EU countries to source from credit-supplying countries outside of the ETS system. 

However, the proposal lacks detail, according to Sultani: “Which type of credit do we want to buy? Which sort of countries do we want to procure from? Who are the countries that the EU envisions as trusted partners in a more fragmented trade world?,” he asked. 

Stakeholders, such as lobby group BusinessEurope have criticised the lack of clarity. “Early preparation on governance and procurement, and greater certainty around a pilot from 2031, will be essential to establish a credible demand signal,” said the International Emissions Trading Association (IETA) on the proposals. The Commission is expected to present a framework for the use of international credits towards the 2040 EU climate target in late 2026.

On the other side of the equation, Muhwati acknowledged that countries within the Southern Africa Alliance and Africa in general may not be ready to fully participate in a global carbon market. “Most countries are still grappling with putting regulations in place. Capacity building is still in its infancy, and it needs to be accelerated,” he said. 

The EU has previously had negative experiences with international carbon credits in its climate architecture. EU companies were allowed to use Certified Emission Reductions (CERs) credits under the Kyoto Protocol´s Clean Development Mechanism as part of the first phase of the ETS. However, the market was flooded with poor quality credits for projects that had little impact on emission reductions. The EU stopped emissions trading under the mechanism in 2020. 

“To be super frank, there's no guarantee that you will have 100-percent high integrity credits in the system and in international procurement,” Sultani told Clean Energy Wire. “But we have reached a situation in which there are no risk-free alternatives.” For buyers in the EU, he added, a centralised procurement body would facilitate mutually beneficial initiatives for involved parties and ensure a stronger buyer signal.

Sultani warned that the reform carries the risk of slowing global mitigation efforts at a time when stalled climate ambition is a major concern. “If I put myself in the position of a country that has the opportunity to sell international carbon credits, I might ask myself: do I ramp up my own NDC ambition only being able to sell a small share of credits to international actors like the EU, or do I deliberately keep my ambition low so I have a broader set of allowances or carbon credits readily available to sell abroad?”

While the EU might launch a pilot programme for international credits in 2031, full operationalisation would only begin in 2036. For potential suppliers who want to access the financial and investment benefits of emissions trading – especially amid current foreign aid cuts and backtracking on climate commitments – the ETS amendments may come too late. 

“The timelines are realistic,” Zimbabwe’s Muhwati said. “10 years seems like a long time, but it´s not. We need rules in place before then to align with Article 6. Let´s not forget that Article 6 only became operational nine years after the Paris Agreement.”

On the supply side, regulations remain a challenge. “Technical capacity building by the EU prior to 2030 could help address this challenge,” Muhwati added. “In addition, the integrity of both supplier countries and EU buyers should be subjected to protocols that ensure we do not cause an overall increase in global emissions. Regulations, policy consistency and technical capacity should be strengthened on both sides.”