THE OXFORDINSTITUTEFOR ENERGYSTUDIESThe creation of a global carbon market:taxonomy of carbon pricing under Article 6IntroductionCarbon pricing is a critical tool to help countries and companies achieve their climate targets by valuingthe extemality of carbon emissions.Carbon pricing exists as a penalty,subsidy,or valuation of a carbonsink with the key aim of delivering a price signal for investment in the reduction or the removal of carbon.The Intergovernmental Panel on Climate Change (IPCC)and the World Bank among many othersconsider it as a key instrument to incentivize and stimulate capital markets to deliver the emissionreductions and removals required to achieve the targets of the Paris Agreement.While a simple concept,the universe of carbon pricing is complex due to the breadth of activities,thevariety of applications,and further what is a myriad of combinations depending on geographicalopportunity and political will.The objective of this Energy Insight is to describe some of the basicfeatures of carbon markets and analyse some of the wider consequences.It intends to distil some ofthe complexity inherent in these markets,not by oversimplifying into a 'singular'specification driven bya misguided desire for one-size-fits-all-be it for simplicity's sake or for business purposes,but bycategorization into an understandable taxonomy.This paper shows why having a one-size-fits-all carbon pricing mechanism is notonly not possible,but that heterogeneity in carbon markets is in fact needed,if they are to reachtheir promised potential.Heterogeneity in carbon markets can be explained by the fact that differentcarbon reduction or removal solutions deliver with differing volumetric potential,at differentimplementation costs and different timescales,and cater to a wide range of buyers prioritizing differentpricing applications.By approaching carbon on a multi-product,specification-based approach,we areable to embrace the inherent heterogeneity and nuance required by reviewing:What are the types of carbon pricing applications?Who determines the specification of a carbon unit?What are the core specifications of a carbon unit?What are the various types of carbon units and how do they vary in cost and scale?What is Article 6 and how will it underpin global carbon markets?The paper will continually reference carbon in the context of a commodity.This is on the basis that theachievement of the Paris Agreement is measured indirectly in tons,and commodity markets haveproven best suited to translate capital to goods and services required when that delivery is on avolumetric basis.Commodity markets have also displayed strong resilience in the face of change,be itEnergy Insight:136Hannah Hauman,Global Head of Carbon Trading,TrafiguraBassam Fattouh,Director,OlESHasan Muslemani.Head of Carbon Management Research.OIESspecification,technology,regulatory,or market structure changes.1 Based on this framework,we makethe following key observations:Carbon pricing is key to achieve climate targets as it delivers a price signal to capital marketsand corporate decisionmakers to prioritize and invest in emission reduction and removals byvaluing the extemality of carbon emissions.The universe of carbon pricing is complex given the breadth of activities:the diverse andevolving specifications due to rapid developments in science and technology;the layeredapproaches due to variability in landscapes,politics,climate ambitions and prices;and fluiditydue to change in policy as climate ambitions increase.The heterogeneity and the complexity of carbon pricing markets should be embraced as thedelivery of emission reduction and removals occur in highly varied types of supply chains.Thisgoes against the apparent desire for simplification that is not practical nor relevant for theproblem set.◆Carbon is not a singular product and instead can be thought of an asset class with differentcharacteristics to satisfy the requirements/preferences of a wide set of investors/buyers.There are continued calls from carbon pricing advocates for a "global carbon price".While thisis admirable from the perspective of encouraging global cooperation and investment towardsenergy transition,this oversimplification of a complex asset class would not deliver the impactand diversified capital investments that are required.Article 6 of the Paris Agreement is the first true global carbon market that will set a standardizedand unified framework for carbon accounting and carbon credit qualities.However,thisstandardization will enhance the stratification presently seen in carbon pricing and carbonmarkets,with differentiated pricing for the various carbon specifications within the overall assetclass.What are the types of carbon pricing applications?Carbon pricing exists in three key forms:as a penalty,subsidy,or valuation of a carbon sink.Carbon penalties apply to "positive"emissions released by an activity or asset on an incremental tonof COze emitted basis.Penalties most commonly take the form of "allowances"-or permits to emitunder regulated cap and trade schemes(or more generally,Emission Trading Systems-ETSs).Otherforms of penalties include regulated carbon taxes and unregulated internal carbon pricing (ICP)bywhich companies may model a theoretical cost of carbon to their business (whether for investmentdecisions or risk/share price exposure).While the mode of delivery may differ,the common thread isthat the price signal is meant to disincentivize future emissions-either via a downturn in production,greater efficiency measures,process conversions or activity changes,or deployment of carbon capturetechnologies.Where successfully deployed,carbon penalties will continue to grow in volume over timeas ambitions and sectors in scope increases,and over time decrease as overall emissions decreasePenalties can be static or progressive,such as in the instance of carbon taxes,or market based,as inthe case of ETSs though for the most established ETS,the EU ETS,the main tool is the scheduleddecrease in annual issuances that guides the market towards lower emissions by issuing fewer permitseach year.Carbon subsidies,defined as an incentive to reduce "positive"emissions or increase "negative"emissions related to an asset or activity take a variety of modes including credits,tax rebates,and otherincentives.Carbon subsidies exist to bridge the economic gap to enable a change in business-as-usualFor example,specification changes such as seen in the oil markets and in the global reduction in the sulphur content ofrefined products.Equally market structure changes,such as the increased commoditization of gas whereby pricing againstcrude oil benchmarks proved imelevant over time and global gas pricing benchmarks are now the norm.2The contents of this paper are the authors'sole responsibility.They do not necessarily represent the viewsof the Oxford Institute for Energy Studies or any of its Members.