A dispute pitting two groups of nations led respectively by Germany and Brazil is holding up work on creating a global market for trading carbon pollution, one of the pillars of the Paris Agreement on climate change.

After bruising talks at a United Nations climate conference last month, the two groups remain at odds on how to structure the system. New carbon markets could allow developing countries to sell emissions credits generated from programs that cut greenhouse gases. The theory is that richer nations could buy those securities, gaining a cheaper option for reaching their own targets.

Germany along with the European Union and industrial countries say that developing nations may “create too many loopholes” with Brazil’s proposal for the market’s rules. An envoy from the South American nation said its position has been misrepresented. The comments, made in response to questions from Bloomberg, follow a decision at the UN talks involving 200 countries to shelve for at least a year efforts to write the part of the a rulebook that might have expanded carbon trading.

At issue is who would be able to sell carbon credits in the new system, which envoys are hoping will spur emissions cuts before the Paris Agreement comes into force next year. The question is contentious because Europe has been working to clear up a glut in its own carbon market, which is the biggest in of its kind in the world. Adding a new source of credits could undo that effort and depress prices, eroding the value of carbon trading as a tool to aid the environment.

“The biggest question is always who’s going to buy the offsets,” said Trevor Sikorski, head of natural gas, coal and carbon at Energy Aspects Ltd., an industry consultant in London. While countries hold back on tighter emission targets that would generate demand, the current debate about increasing supply doesn’t demonstrate a “great understanding of the use of markets.”

Markets under the Paris deal are one of the policy tools that countries can use to reduce fossil fuel pollution. While the world as a whole will need to reduce those emissions, lawmakers in the U.S. and Europe have sought to guarantee ways to use financial markets to make those cuts in the most efficient way. 

The UN’s first effort at a global carbon trading system had mixed results. Under the 1997 Kyoto Protocol, the UN built up a Clean Development Mechanism that spurred emissions-reducing projects in exchange for credits that could be sold to places with cap-and-trade systems. Those CDM credits have tracked near zero for six years because countries mostly aren’t using them to meet emission targets any longer – and the EU has declined to extend rules that allowed those participating in the continent’s cap-and-trade system to use CDM credits for compliance through 2020.

The debate at the UN talks is about how to either revive that market or create an alternative, which would be known as the Sustainable Development Mechanism. The new system has vast potential. A report from the UN Environment Program suggests that demand for emission reductions could reach 32 billion tons by the year 2030, more than 17 times the total yearly supply in the EU’s existing market. While only part of that might come from the new programs, it indicates why tight rules are needed to govern how credits flow across borders.

Brazil’s Position

Brazil wants a new system to boost investment in projects that reduce emissions – and to generate revenue from selling credits.

It says the voluntary and “bottom up” nature of the Paris climate deal means not all countries will take on a target that covers their whole economy. In those cases, private industry should be able to sell credits from “additional” projects to those parts of the system that are covered by targets. Germany is resisting that idea, signalling that only countries and companies covered by the targets should be able to participate in trading.

If Brazil had its way, nations or companies could buy credits in one of the new markets that would cover their responsibilities. Sellers of those credits could benefit as long as the emissions cuts are beyond the targets logged with the UN by the nation generating the credits.

Thiago Mendes, secretary of climate and forests at Brazil’s Ministry of Environment, said developing nations should for a while be allowed to have emission limits that cover only some sectors of their economy. Those countries would still limit emissions under the Paris deal. Even projects outside the industries facing restrictions would be able to sell into the new system – so long as the investments are green enough.

“Those reductions should be counted only towards the national targets of the purchasing country, with no impact on the targets of the country that hosted the project,” Mendes said. He rejected accusations from pressure groups and industrial nations that Brazil’s measures would allow double counting of permits, saying the charge “doesn’t make sense – if the reductions have not been counted a first time, how can they be double counted?”

Germany’s View

Some European nations including Germany are refusing to back Brazil’s plan, saying it gives emerging-market countries too much of an advantage.

Germany wants a completely new system with a “clean and uniform” design, the nation’s Deputy Environment Minister Jochen Flasbarth, said in an interview in Berlin. He’s focused on eliminating the possibility of double counting the emissions reductions made by countries. For example, if a country generates credits by preserving a carbon-absorbing forest, it shouldn’t be able to both take credit for that decrease in its own emissions and sell a credit to another country that will do the same. 

Germany says Brazil’s stance isn’t strict enough, because it might allow some nations selling emission credits to fudge that accounting. At the same time, Flasbarth insists stricter measures would benefit developing countries like Brazil by creating ”enormous demand” for securities offsetting emissions.

The airline industry is already planning its own global carbon market. Under that program, pollution allowed from industry worldwide would be frozen. Flasbarth sees that system creating a ”huge market” by requiring airlines that want to expand to buy carbon credits that offset their increased emissions.

“This isn’t about rich countries benefiting from poorer ones,” Flasbarth said. “This is an opportunity to create a big new market. They will have buyers of certificates which will pay for climate protection. There are a lot of airlines in Third World countries. A huge market will be created. I’m sure of that.”

At the same time, he won’t sign up to any program that would make the carbon market leaky in terms of its ability to clamp down on emissions. He sees the UN’s existing CDM program as an example of a poorly designed system that doesn’t work well. The CDM ran out of demand for its credits because countries didn’t take on tight enough targets for cutting pollution and didn’t use the credits generated for that system for compliance.

“We must be able to look at the transaction – it has to be a transparent inventory and one that’s free of corruption,” Flasbarth said. “We saw that with the clean development mechanism, where we set the wrong incentives, any reform of the rules has been blocked by the developing countries. We need something new under the Paris Agreement. You have to really set up something that’s credible,” Flasbarth said.

Outlook for Talks

Ultimately, envoys will probably compromise and transition from the existing system, potentially over 10 years, and allow a little of what each side wants, said Richard Saines, a partner and climate policy specialist at Baker & McKenzie LLP in Chicago who received an award from France for his contribution to the Paris agreement.

“It’ll be an amalgam of all the various pieces that will hopefully strike the right balance,” Saines said by phone. “This is the messy sausage-making collective, consensus, individual-bottom-up approach that we live in and we need to figure out a way to create incentives to race to the highest level of ambition.”