Brazil should learn from others in the development of its regulated carbon market

Introduction

The impacts of climate change have begun to cause sufficient damage to people’s lives and the natural environment that has led to impacts on the operations of numerous companies that are part of global value chains in the form of yearly record-breaking temperatures, longer droughts, increased number and intensity wildfires, and increased geographic spread of vector-borne diseases, among others. This has led to many leading firms to reassess the impacts of their value chains on the environment and vice versa. Public and private initiatives in the form of carbon markets provide frameworks that offer the promise of reducing GHG emissions via market mechanisms in a flexible manner and at the least cost.

While the effectiveness of carbon markets for reducing GHG emissions continues to be debated in scientific literature, the world, through the Paris Agreement’s Article 6, is betting on them to help meet GHG reduction targets in order to maintain global warming to below 1.5ºC by 2100. Many regulated and voluntary carbon markets (VCM) have emerged around the world even before the Paris Agreement. There are currently 28 regulated markets in force, another 9 under development, and a further 11 under consideration. Currently, voluntary market platforms are dispersed or project developers sell directly to buyers, but a McKinsey report estimates that VCMs could be worth up to $50 billion by 2050.

Regulated carbon markets tend to take the form of cap-and-trade, i.e., emissions trading system (ETS), whereby an initial quantity of tradeable carbon allowances are given or sold to companies that are regulated by the carbon market, which may then buy and sell these allowances as necessary. VCMs tend to function on the structure of baseline-and-credit, whereby carbon credits are assessed on a per project via the reduction or avoidance of GHG emissions against a counterfactual baseline scenario of GHG emissions. Latin America is positioned as a potential leader in the development of carbon markets as many national and subnational programs already exist and the continent is abundant in nature-based solutions potential. Brazil is the largest country and Latin America and is home to approximately 60% of the Amazon. There are ongoing debates around the implementation of a regulated carbon market and it would be wise to look around at other ETSs’ successes and failures and how aligning its carbon market with others could better position it to shape Article 6 debates of the Paris Agreement.

GHG emissions in Brazil

Brazil’s GHG emissions profile shows that the majority of emissions come from changes in land use followed by the agricultural sector. These two are not mutually exclusive, as the expansion of soybean and cattle ranching are the leading causes of deforestation in the Amazon. It is important to note that Brazil’s electricity mix emits significantly less GHG than other major countries, this is due to approximately 60% of its electricity generation coming from hydro and renewable accounting for approximately 80% of total electricity generation. This means that the industrial sector is not a major source of Brazil’s GHG emissions, unlike other major economies, but rather following land use change, agriculture, is the transportation sector. 

Following the Paris Agreement in 2015, countries must submit updated NDCs every five years that are more ambitious. Unfortunately, Brazil’s updated NDC in 2020 attempted to use some methodological tricks to present a more ambitious target but was actually less ambitious compared to its original 2015 NDC, increasing net emissions from 1.3 GtCO2e in 2025 and 1.2 GtCO2e in 2030 to 1.8 GtCO2e in 2025 and 1.6 GtCO2e in 2030. This further undermined Brazil’s reputation as an environmental leader, something it seeks to recover now.

History of carbon market development in Brazil

Since the implementation of the Kyoto Protocol in 2005, which established the clean development mechanism (CDM), Brazil has seen many carbon credit projects developed, generating the third most CDM credits of any country. 

Importantly then, when Brazil introduced the concept of a national carbon market through the National Climate Change Policy in 2009, this law covers, not just fixed sources, but also mobile sources such as public transportation, and importantly the agriculture sector. In the following years, there was little action from the public sector regarding the development of a carbon market, but the VCM continued to grow in Brazil through offset projects that were in large part accredited via Verra, the largest certification organization. The VCM in Brazil has rapidly increased since 2019 ranking it fourth in the voluntary market behind the US, India, and China.

Research and discussions around the Brazilian carbon market continued. The World Bank’s Partnership for Market Readiness (PMR) provides technical assistance to Latin American countries. In the case of Brazil, PMR worked with the Ministry of the Economy to understand the impacts of a carbon tax or carbon market on relevant sectors, it found a carbon market under the cap-and-trade model to be the most appropriate mechanism. The Brazilian National Confederation of Industry also supports the establishment of a carbon market, since it will provide legal security and transparency without introducing an additional tax burden. 

Importantly, the business sector began to recognize the opportunity around the VCM. In 2020, the Environmental Ministry implemented the Forest+ Carbon Program, which established the National Commission for REDD+ in Brazil, the development of a digital platform for project registration, and outlined acceptable methodologies that are aligned with the Paris Agreement. Then in 2021, the government passed the National Policy of Payment for Environmental Services (law 14,119/2021) 2021. This national policy follows many state-level policies in Brazil.

Current debates around the carbon market in Brazil

In May of 2022, the Government issued Federal Decree 11075/2022, which regulates the National Policy on Climate Change, making it a first step in establishing a carbon market. It outlined definitions of carbon credits, introduced the concept of sectoral plans for reducing emissions over time, and created the National Greenhouse Gas Emissions Reduction System (Sinare), which will be the central registry. However, it did not create the actual ETS, i.e., ‘the rules of the game’.

The election of Luiz Inácio Lula da Silva, popularly known as Lula, presented hope for Brazil to return to its leadership role in global environmental politics. Under his terms as president from 2003-2010, Brazilian deforestation fell dramatically due to increased funding and capacity for command-and-control style policy enforcement. Under the previous administration of Jair Bolsonaro, deforestation rose dramatically and environmental laws and regulations were undermined. Lula ran on an environmentally progressive ticket promising to restore the institutional capacity, but he cannot reuse the same formula as before since he faces a much less favorable global economic scenario and a conservative Congress that will not easily give in to his environmental agenda. The development of the Brazilian ETS is currently under debate by the government and Congress should consider the experiences of major ETSs and that of its neighbors in designing its own ETS. 

Since the federal decree, debate in Congress has heated up around the creation and regulation of a national carbon market. One of the current bills discussed that could establish a carbon market is PL 528/2021, it establishes an inventory system but leaves it up to the Ministry of the Economy to establish the design of the market, thus this bill does not establish GHG emissions limits, but rather suggests emission reduction plans per sector. Unfortunately, these laws do not clarify connections with the VCM or other international carbon markets. A more advanced bill is PL 412/2022, which addresses aspects of integration with the VCM and provides an outline for a plan to develop the total amount of credits for the market. The current Brazilian government supports the creation of a carbon market and believes that an ETS could increase the country’s GDP by 5% by 2030. 

The Paris Agreement and carbon markets around the world

Under Article 6 of the Paris Agreement, an international carbon market will be established. One important tool of this article has become known as the sustainable development mechanism (SDM), the successor to the Kyoto Protocol’s clean development mechanism (CDM), which is a means for the private sector to finance carbon-neutral or negative projects and receive carbon credits. Brazil is well-positioned to attract many projects in the areas of forest conservation, solar, wind, hydrogen, recycling, waste-to-energy, and energy efficiency. 

Some of the major considerations when designing an ETS concern its cap level and here it is important to understand the country’s emissions profile and which sectors should ultimately be included; in the case of Brazil, this must include the agriculture sector. The initial allocation mechanism, whether these will be marketed, based on historical emissions (‘grandfathered in’), or benchmarking.

In addition, Brazil can look to its neighbors' endeavors to develop ETSs in similar social, political, economic, and environmental contexts. Mexico’s ETS is currently finishing its pilot phase and beginning its fully operational phase. These ETSs of the region can provide important lessons for ETS design considerations such as pricing, GHG monitoring programs, impacts on sectoral competitiveness, and integration with other major ETS. 

Conclusion

Brazil is back, as Lula declared at COP 27 in Egypt in 2022, but in order for the world to take him and Brazil seriously it needs to walk the walk and not just talk. Establishing a robust ETS that integrates with the strong VCM, and just as importantly, other major ETSs around the world will help reestablish Brazil as a green superpower which it can leverage in climate negotiations. The Brazilian government can reinforce its environmental bonafide by strengthening its GHG emissions reductions ahead of the next NDC update in 2025, not permitting new offshore oil and gas development at the mouth of the Amazon River,

In this context, the current debate around a market mechanism, such as an ETS offers a viable policy option to aid Brazil in meeting its GHG emissions reduction targets, shape the international debates surrounding Article 6 of the Paris Agreement, and help reestablish the country as an environmental leader. The establishment of a robust national carbon market will accelerate the decarbonization of important sectors of the Brazilian economy. This is crucial to these sectors’ competitiveness, especially in the wake of the EU’s carbon border tax and its deforestation regulation aiming to rid supply chains of products associated with deforestation, the US is also considering a carbon border tax.

The establishment of a national carbon market in Brazil will need to overcome confidence in the measuring, reporting, and validation (MRV) methodologies for the complex projects likely to be implemented in Brazil (e.g., questions of additionality and leakage in conservation projects). Still, Brazil has an enormous opportunity to become a major source of carbon credits in both the VCM and internationally regulated carbon markets. At this stage, it should prioritize integrating its carbon market with other major carbon markets and VCMs, and improve its skilled workforce. It will then be better positioned to shape the development of the international carbon market and the SDM.