Viktor Kovalenko, Partner, Head of Sustainability Services in Central Asia, Caucasus, Ukraine at EY

Anara Samambayeva, Consultant of EY Services

The Kyoto Protocol on the Reduction of Greenhouse Gas (GHG) Emissions laid the foundations for the transition to a "green" economy, introduced a mechanism for setting and trading quotas and determined its regulatory nature for the next years. One of the tools for transition to "green" economy are climate projects that involve measures either preventing, namely aimed at reducing GHG emissions, or compensating, i.e. the absorption of already realized GHG emissions, or combination of these measures. The results of such projects are expressed in carbon units, which represent the amount of emissions prevented or absorbed in tons of CO₂ equivalent.

There are two types of carbon unit markets: regulated and voluntary, where the seller is the party that underutilizes its pollution credit or implements a climate project, thereby generating carbon units; and the buyer is the party that wants to purchase these units to compensate for its own emissions or fulfill its pollution credit obligations. The main difference between a regulated market and a voluntary one is a top-down approach, where national goals for reducing emissions and/or achieving carbon neutrality dictate quotas for C0₂ emissions.

The reverse bottom-up approach is characteristic of the voluntary carbon units market, where issuers themselves seek to reduce their carbon footprint in order to fulfill corporate obligations to reduce climate impacts, improve the company's image, increase investment attractiveness, receive premiums for carbon-neutral products, or prepare for future offsetting of carbon units with the introduction of regulatory instruments for emission control.

Another significant difference between the markets is the price of carbon. Thus, the average cost of carbon units in the voluntary market is 10 times lower than in the regulated one. Although there are many factors affecting the value formation according to 2020-2021 estimates, there is a general trend towards an increase in the price of carbon in voluntary markets. Therefore, for example, large issuers from the oil and gas sector proactively buy out entire climate projects in order to reduce the cost of buying individual units at higher prices in the future and get better compensation for their emissions.

Climate projects should be developed on the basis of four fundamental principles specified in the international standards for certification of climate projects (Table 1).

The most popular international standards for checking and confirming the effectiveness of the project (85% of the market) are the Verified Carbon Standard (VCS) and the Gold Standard (Gold Standard, GS). In 2010-2020, the dynamics of demand (+27%) for carbon units produced according to these standards, on average, outstrips the dynamics of supply (+23%).

The algorithm for trading carbon units on the voluntary market consists of the following main stages.

1. Explaining the idea of the climate project, taking into account the economic effect, associated risks, opinions of stakeholders.

Design of the project with a description of method used for monitoring and assessing the volume of reduced/absorbed GHG emissions, the accompanying environmental and social effect of the project, as well as evidence of compliance with the complementary principle.

1. Verification of the design of the project by independent experts to be able to proceed with its implementation, the so-called validation of the project.

2. Verification of the project by a third party after its implementation to verify the effectiveness of the project.

3.   Release of a carbon unit in accordance with an international standard, registration in the register of carbon units and continued verification during the project implementation period.

4.   Purchase of a carbon unit through specialized companies with further write-off from the register.

Depending on emission control legislation, voluntary carbon units may become part of existing or emerging CO₂ emissions trading systems, where they can be put into circulation in order to meet the established emission quotas. The focus of the project will be an important factor here. Both international and national voluntary carbon unit markets are dominated by climate projects in relation to forest and land resources, energy efficiency and renewable energy sources.

There is the potential to use carbon units to reduce the carbon tax as compensation for emissions. Thus, the results of climate projects verified according to VCS and GS standards are already counted by regulatory mechanisms when reducing taxes in Colombia and South Africa, CORSIA (scheme for compensation and reduction of carbon dioxide emissions for international aviation), and the mechanism for reducing emissions for oil and gas companies Upstream emissions reduction, which involves offsetting initiatives to reduce emissions during production of fuel.

The Federal Law of the Russian Federation "On Limiting Greenhouse Gas Emissions", which entered into force in 2021, has already fixed the concept of climate projects and laid the foundation for regulating emissions. The system of registration, accounting and offset of the results of climate projects is currently being developed, but the draft Decree of the Government of the Russian Federation dedicated to this indicates the possibility of implementing climate projects certified according to international standards (VCS, GS). Taking into account the results of the Sakhalin experiment, it is expected to create a regulated TES and a voluntary mechanism for trading carbon units at the national level. The implementation of climate projects will be accompanied by such support measures as tax incentives, "green" financing and industry-wide support for investment projects.

The climate agenda is becoming more and more relevant in Kazakhstan: there is an emissions trading system (KazTES), according to the Updated NDC of Kazakhstan and the Doctrine of Carbon Neutrality, it is planned to strengthen the regulation within the framework of KazTES and the introduction of carbon tax for non-quota sectors of the economy and sources of GHG emissions, it is planned to develop by-laws necessary for the full launch of regulated carbon market. Also, it should be kept in mind that many other planned investment projects aimed at upgrading production facilities and introducing the best available techniques (BAT) actually lead to a reduction in negative environmental impact and indirectly entail a reduction in greenhouse gas emissions.

To increase the opportunities for the successful implementation of Kazakhstan's climate projects, the following regulation is necessary:

• strengthening the national system for limiting greenhouse gas emissions and carbon units trading (KazTES);
• international regulation of the possibility of linking projects to cross-border carbon trading mechanisms/ mechanisms of customs and economic unions;
• creating a wide range of national measures of state support and stimulation of climate projects and the introduction of BAT.

In the context of developing climate legislation of Kazakhstan and the seriousness of the consequences of the introduction of appropriate regulatory standards for the country's industry, careful study of each potential project with the involvement of climate experts, lawyer sand tax specialists is necessary.

EY has formed an international climate group consisting of experts, lawyers and tax specialists on climate issues, with access to the best practices on decarbonization in all countries where we conduct projects.

Examples of implemented projects with our participation: analysis of the impact of carbon control (both national and international) on investment plans and components of the cost of production of industrial companies), inventory of greenhouse gas emissions and calculation of the carbon footprint of products, development of decarbonization programs for the company, structuring the sale of UER, international benchmarking of legislation on carbon farming and others.

The EY team is ready to provide comprehensive support for the search, preparation, implementation and monetization of climate projects, including:

• analysis of planned investment projects aimed at reducing the negative impact on the environment, forthe possibility of implementing climate projects based on them, as well as "carbon testing" in relation to such projects;
• assistance in the implementation of internal carbon pricing approaches;
• analysis and selection of suitable applicable methodologies for implementation of climate projects;
• legal and tax structuring of climate projects taking into account potential markets forthe implementation of carbon units;
• preparation of step-by-step map of the climate project implementation;
• analysis of carbon footprint of products and development of programs to reduce it;
• assistance in the preparation of proposals to improve Kazakhstan's climate legislation.