Creating a Carbon Market: Emission trading mechanism to facilitate climate action

The Ministry of Power recently notified the Energy Conservation (Amendment) Act, 2022, amending the Energy Conservation Act, 2001 in order to empower the central government to put in place a carbon market and specify a carbon credit trading scheme. Under this, the central government or an authorised agency will issue carbon credit certificates, which will be tradable, to companies or individuals registered and compliant with the scheme. Importantly, the carbon credits will be used on priority within the country to meet the nationally determined contributions. Industry experts share their views on the proposed carbon credits market and its likely outcome, along with the key implementation issues and challenges…

What are the expectations from the proposed carbon credits market in India? What will be the outcome and impact of a carbon credit tra­ding scheme?

Rohit Bajaj

The threat of climate change has been duly recognised, and nations over the wo­rld have declared their targeted Na­tio­nally Determined Contributions (NDC) following the historic Paris Climate Ac­cord of 2015. Despite this, according to UNEP’s recently released Emission Gap Report 2021, to get on track to limit global warming to 1.5 °Celsius, the world ne­eds to achieve an additional 28 GtCO2eq reduction in annual emissions by 2030, over and above the updated unconditional NDCs. India has also set ambitious targets of reducing carbon intensity by 45 per cent by 2030 (with respect to 2005 levels) and of becoming a net zero nation by 2070. In order to decarbonise the Indian economy at an accelerated pace, an am­endment was made to the Energy Con­servation Act 2022, to facilitate the required policy and regulatory framework for the creation of a national carbon market in India.

As per the draft national carbon market blueprint released by the Bureau of Energy Efficiency (BEE), it is expected that the perform-achieve-trade (PAT) sc­he­me shall transition to a broader sc­ope in a phased manner to create India’s na­tional carbon market. In the first phase, energy saving certificates shall be converted to carbon credit certificates (CCC) through the fungibility formula. RECs may also be allowed to be converted into CCCs; however, this is subject to further clarity as the regulations are yet to be announced.

We expect the early formulation of a policy regulatory framework to assign the responsibilities of regulatory functions and registry functions to the nominated bodies. Since the national carbon market will be a revamped version of the PAT scheme, it is expected that the Central Electricity Regulatory Com­mission shall be the regulatory body, and Grid Con­tro­ller of India Limited (formerly Power Sys­tem Operation Cor­po­ration) the registry body. This could expedite the im­plementation of carbon trading in India. It is also expected that the fungibility of different compliance instruments such as energy saving certificates (ESCerts) and RECs shall be im­plemented in a manner that creates a win-win proposition for both ins­tru­ments, and promotes faster decarbonisation. As the Emission Trading Scheme (ETS) mechanism shall involve emission reduction targets for different energy-intensive industries, it should be announced well in advance to get stakeholders on board. Moreover, the entire value chain of monitoring, re­por­­ting and verifying needs to be prepared ac­cordingly. The penalty mechanisms also must be strengthened to en­sure compliance.

Once policies and regulations are put in place, the trading of CCC shall begin at the power exchanges, in line with ESCerts. The competitive and transpare­nt trading of CCCs/compliance instruments on power exchanges will provide robust market signals to industries and corporates for the optimum allocation of capex towards decarbonisation. Since the compliance carbon market is expected to cover energy-intensive industries that represent 50 per cent of India’s greenhouse gas emissions, a vibrant carbon market shall help in the mobilisation of capex and help meet the compliance or disclosure requirements for environmental, social, and governance purposes; bu­siness responsibility and sustainability reporting; the Electricity Act, etc. The ex­changes shall also help industries and corporates purchase CCCs/compliance attributes in a competitive and transparent manner to meet the compliance re­quirements for international exports under policies such as the Carbon Border Adjustment Mechanism.

Manish Dabkara

Climate action is gaining momentum and countries worldwide are accelerati­ng their progress towards mitigating climate change. From setting ambitious net-zero goals to designing roadmaps to achieve those goals, global climate ac­ti­on is in full swing and so is the demand for carbon credit as a popular offset me­chanism and an essential part of climate change mitigation strategies.

The Science-Based Target initiative suggests that “purchasing high-quality carbon credits in addition to reducing emi­ssions along a science-based trajectory can play a critical role in accelerating the transition to net-zero emissions at the global level.”

The situation is similar in India as well. Since India has pledged to become net-zero by 2070, more businesses and or­ga­nisations are setting their own net-zero goals. This drive to save the future is expected to gain a significant push, as the government plans to develop a do­mestic carbon market and National Em­is­sion Trading Scheme (ETS). Additio­nally, it will strengthen India’s position in the global climate action scenario while facilitating the transition by channelising the required green finance thr­ough carbon market avenues to a more emission-efficient economy.

The move will revolutionise the Indian carbon credit market by unlocking new opportunities for Indian sellers of carbon credits, who will now have five different markets to choose from:

  • Domestic Compliance Carbon Markets
  • Domestic Voluntary Carbon Markets
  • Article 6.2 of the Paris Agreement Car­bon Markets
  • Article 6.4 of the Paris Agreement Car­bon Markets
  • International Voluntary Carbon Mar­kets

This will increase the demand for credits amongst Indian businesses and organisations with a renewed focus on greenhouse gas (GHG) emission reduction and increased private sector participation in combating climate change. The commitments of India Inc towards carbon neutrality and the Indian carbon market will push demand for voluntary carbon credits in India in the years to come. The annual demand for voluntary carbon credits in India is expected to cross 500 million units by 2030.

Prabhajit Kumar Sarkar

The notification of the Energy Con­se­rvation Amendment Act 2022 is a pathbreaking event with respect to the establishment of a carbon credits market in the country. The amendment provides a legal framework for a carbon market, with the objective of incentivising actio­ns for emission reduction.

This follows numerous other actions such as declaration of the net-zero target of 2070 to demonstrate India’s leadership and ambition for climate change mitigation. In this backdrop, the type of the carbon market and the perspectives of In­dian stakeholders on its shape and form will play a vital role in the evolution of the carbon credit market.

Carbon markets are markets where a to­nne of carbon dioxide equivalent (CO2e) is commodified as a tradeable unit, either as an emission allowance issued in a “cap-and-trade” system, or as verified em­ission reduction, or as a re­mo­val credit issued in a baseline-and-credit (essentially “project-based”) system.

In India, two kinds of carbon markets, na­mely “project-based” and “cap-and-trade”, are being deliberated on on different forums. Carbon markets are in­tended to put a price tag on GHG emissions, leading to emissions reduction. Market-based carbon pricing instruments will enable industries to proacti­vely plan their future capex and factor in the cost of carbon emissions in their business decisions.

What are the biggest issues and challenges in its implementation?

Rohit Bajaj

As per the BEE blueprint paper, the compliance carbon market will take the shape of an ETS model, in line with some of the existing compliance markets in the world such as the EU ETS. Some of the issues and challenges in implementing a national carbon market are:

  • Establishing the baseline and emission cap limits for different sectors, which is required for the ETS mecha­ni­sm. A consensus needs to be built on whether the cap should be abso­lute, sector-wise, for faster decarbonisation; or more relaxed, based on em­i­ssion intensity reduction goals linked to India’s NDC. Under an ab­so­lute cap model, the faster decarbonisation sh­a­ll make Indian industries more competitive in international markets, whi­ch would also me­an fas­ter capex dep­loyment to­war­ds low-carbon techno­lo­gies. How we support the faster capex deployment and build an overall consensus to create a win-win proposition will be important.
  • Lack of clarity on how the simultaneous implementation of two complian­ce mechanisms such as REC and ETS shall be structured so that there is harmony in terms of accounting, flexibility of options for obligated entities, compliance and penalty calculations.

Manish Dabkara

We believe that a National ETS will bring fair play, unlock market potential and increase transparency in the buying and selling of carbon credits. Every sector, busi­ness or organisation aiming to re­du­ce its carbon footprint will benefit fr­om a robust carbon market in the country.

The demand for carbon credits is in­c­reasing and global climate action is ac­celerating, which makes it the right time to create a carbon market of our own. There will not be many challenges in its implementation. The government will have to ensure that the market is well-structured, transparent and supported by strong regulatory enforcement to develop substantial demands and ensu­re that the minimum prices of carbon offsets are in line with the country-def­i­ned development agenda. It will help provide indexing facilities that can be leveraged for carbon finance instruments, thus helping India attain its Nationally Determined Contribution (NDC) goal.

The government can take some important measures, such as the ones mentioned below, to ensure that the carbon market is transparent and vibrant.

  • Effective implementation of national legislation (EC Act 2022) by Parlia­me­nt, to pave the path for the formation of requisite market systems and legitimisation of the National Carbon Re­gistry and the National Carbon Ma­r­ket to meet the country’s commitments under its NDC.
  • Involving the respective line ministries, which may include the Minis­t­ry of Environment, Forest and Climate Change; the Ministry of Power; the Mi­nistry of Finance; and the Ministry of Commerce and Industry, to effectively form the national policy and re­gu­la­tion for the formation of a national ca­rbon market.
  • A market stabilisation fund to support the minimum prices of various carbon credits generated from projects with national developmental interests.
  • Creating an effective level playing field to support private sector participation in the origination of carbon emission reduction projects, and providing co­untry endorsement to participate in International Voluntary Carbon trading, bringing requisite foreign direct investments to India.
  • In the recent future, with the advent of operational modalities under Arti­cle 6 of the Paris Agreement, namely the Su­pervisory Body of the United Na­­tio­ns Framework Conven­tion on Climate Change and its administered Interna­tional Carbon Registry, the Indian Na­tional Carbon Registry sh­ould effectively be linked on a real-time basis with the Inter­national Carbon Registry.

Prabhajit Kumar Sarkar

Many countries are explo­ring ways of pricing GHG emissions, as a climate ch­­an­ge mitigation tool. To realise the full potential of market-based instruments, it is important to maintain inte­grity and quality.

Further, in the existing REC and Energy Saving Certi­ficate (ESCERT) mechani­sms, the Indian experience revolves en­tirely around project-based approa­ches. Thus, there is limited understanding of the “cap-and-trade” mechanism, creating a need for a sustained and de­ep engagement on the subject. The limited understanding of this mechanism in the energy space has been gleaned from the Perform, Achieve and Trade (PAT) scheme, a market-based mechanism introduced in 2012 by the Bureau of Energy Efficiency (BEE) to accelerate carbon emission reduction by incentivising energy savings through the trading of ESCERTs.

This is a cyclic sc­heme, where certain notified energy in­tensive units with threshold energy consumption are gi­ven specific energy consumption re­d­u­c­tion targets over a cycle of three yea­rs. Overachievement above the assi­gned targets will result in tradable ESCERTs, whereas, underachievers must comply by purchasing the ESCERTs or by paying a penalty. BEE has rolled out seven PAT cycles as of March 31, 2022, with a total of 1,073 industri­es/establishm­ents, referred to as “designated consu­mers”, covering 13 sectors, for which the monitoring and verification of PAT Cycles I, II and III have alrea­dy been carried out. BEE has published the draft National Carbon Market paper, providing a phase-wise plan for migrating from the PAT scheme to an ETS.

The EC Amendment Act 2022 proposes to create a “voluntary” carbon credit ma­­­­rket, where carbon credits issued by a nodal agency will be sold to voluntary bu­yers, including organisations and individuals. The proposed carbon markets will have a crucial role to play in effectively and efficiently channelising cli­mate finance towards sustainable pro­jects by providing market signals to investors and corporates.