As the world grapples with the dire need to curb greenhouse gas (GHG) emissions, the Paris Agreement’s ambitious target of limiting global warming to 1.5°C stands as a guiding principle. Achieving this goal requires a multifaceted approach, integrating various strategies and technologies. One such strategy is the establishment and expansion of carbon markets, which offer a promising mechanism to address the complex challenge of emission reduction.
In a carbon market system, countries, companies or organisations trade carbon emission allowances. These allowances are essentially permits to emit a certain amount of carbon dioxide or other GHGs. The target is to create a financial incentive for industries to reduce their emissions. Entities that can reduce their emissions below the allotted cap can sell their excess allowances to other entities struggling to meet their targets. This market-based approach encourages overall emission reduction, while allowing flexibility for participants.
In India, the government plans to develop the Indian Carbon Market (ICM), where a national framework will be established with an objective to decarbonise the economy by pricing the GHG emissions through trading of Carbon Credit Certificates. The Bureau of Energy Efficiency, the Ministry of Power, along with the Ministry of Environment, Forest and Climate Change has been working with industry stakeholders on a number of initiatives to enable this transition. In the Union Budget 2024-25, the finance minister noted that a roadmap to transition hard-to-abate industries from energy efficiency targets to emission targets is forthcoming. This is a critical step for India as it prepares to launch a new carbon market.
Carbon markets – background
Carbon markets are designed to be flexible, market-based solutions to the problem of GHG emissions. They provide a framework through which emission reductions can be achieved more efficiently, rather than through direct regulations alone.
Under the carbon markets system, emitters who exceed their emission caps must purchase carbon credits or face penalties. This adherence to the “polluter pays” principle ensures that those who contribute to pollution bear the costs associated with their emissions, creating a financial incentive to reduce the output. Additionally, carbon markets facilitate cooperation among emitters by providing a common platform for trading emission reduction. This collaborative environment encourages investments in low-carbon technologies and initiatives, expanding the overall impact of emission reduction efforts.
Compared to traditional command-and-control regulations, carbon markets offer a more cost-effective approach to achieving emission reduction. By allowing market forces to determine the price of carbon, these systems help minimise the economic burden of compliance. Furthermore, carbon markets grant emitters the flexibility to choose how and when to reduce their emissions.
Beyond regulating emissions, carbon markets can also serve as a source of financing for decarbonisation projects. The revenue generated through the sale of carbon credits can be reinvested in green technologies and sustainability initiatives. In an efficiently functioning carbon market, competition drives innovation and emission reduction. A well-designed carbon pricing mechanism creates economic incentives for companies to seek out the most cost-effective and innovative solutions to cut their emissions.
Steps towards ICM
Towards the development of the ICM, the market framework was set in motion by the Energy Conservation (Amendment) Act of 2022. Subsequently, the Carbon Credit and Trading Scheme (CCTS) was notified in July 2023.
The ICM builds on India’s existing perform, achieve and trade (PAT) scheme, which targets energy-intensive industries such as steel, cement and power. The new carbon market in India is an evolution of the PAT scheme. Initially, the PAT scheme was designed to enhance energy efficiency in industrial sectors, which yielded some positive results. However, the scheme faced significant limitations, such as low emission reduction and weak implementation mechanisms, particularly in sectors that are difficult to decarbonise, such as steel, cement and power.
To address these gaps, India is moving towards the CCTS. Despite some progress, the PAT scheme has faced several challenges, including lenient targets and excessive allowances, which have led to poor market liquidity and low carbon credit prices. The CCTS seeks to address these issues by setting more ambitious targets and creating a more effective trading environment. Experts estimate CCTS can reduce 10-15 per cent of India’s industrial emissions by 2030.
Challenges and concerns
Implementing a carbon market presents myriad challenges, particularly in a diverse and rapidly developing country such as India. One of the foremost challenges is setting ambitious and realistic emission reduction targets as noted by a recent report The Indian Carbon Market: Pathways towards an EffectiveMechanism, by the Centre for Science and Environment. India’s previous schemes, such as the PAT scheme, have been criticised for setting unambitious goals, which led to overachievement of targets and oversupply of energy saving certificates (ESCerts). This excess supply caused market prices for carbon credits to plummet, thereby reducing the financial incentives for industries to pursue significant emission reduction. As the new CCTS is introduced, the challenge remains to establish stringent targets that will drive genuine progress, instead of mere compliance according to experts.
Another critical hurdle is market liquidity and the price of carbon credits. In India’s carbon market, as well as in other global markets, the low price of carbon credits has been a persistent issue. Low pricing diminishes financial benefits for companies to engage meaningfully in reducing emissions, weakening the overall impact of the carbon market. This problem is further exacerbated by the limited market liquidity, where fewer participants and transactions make it difficult to establish a dynamic and responsive trading environment. In addition, India’s carbon market faces challenges related to transparency and data accuracy, especially for smaller industries that rely on informal supply chains. Ensuring the integrity of emission data and preventing fraud, as seen in other emission trading schemes worldwide, is essential for the credibility and success of the market.
Additionally, the inclusion of offset credits within the carbon market poses risks of oversupply and double counting, which can erode the effectiveness of emission reduction efforts. Offset credits allow companies to claim emission reductions achieved by projects outside their immediate operations, but excessive reliance on offsets can dilute the impact of direct mitigation actions. Moreover, the lack of a robust market stability mechanism in the ICM causes more uncertainty. Stability mechanisms, such as those used in the European Union’s Emission Trading System, help regulate the flow of credits into the market in response to unforeseen events, maintaining balance and ensuring that price signals remain strong. Without such safeguards, India’s carbon market could face volatility and also weaken long-term decarbonisation efforts.
Further, the challenge of including small and medium-sized enterprises (SMEs) in the carbon market cannot be overstated. Many of these smaller players operate with outdated technologies, have a limited access to financing and often lack the resources to comply with emission targets. As large industrial sectors are integrated into the carbon market, SMEs may struggle to compete, potentially leading to unfair competition and market distortions. Addressing these challenges will be key to ensuring that the carbon market not only reduces emissions but also fosters equitable and sustainable economic growth.
The way forward
The Ministry of New and Renewable Energy, in collaboration with the Carbon Markets Association of India, EY and Shakti Sustainable Energy Foundation, recently concluded a workshop highlighting the country’s dedication to achieving its net-zero targets and the critical role of carbon markets in this journey. Although India’s carbon market is still in its early stages, it holds a tremendous potential to mobilise the necessary investments for the country’s green energy transition. One of the key focal points of the workshop was the potential of green hydrogen as a clean energy source. Green hydrogen, produced using renewable energy, is viewed as a crucial component in decarbonising industries that are difficult to electrify, such as steel, cement and heavy transport. By integrating green hydrogen into the carbon market, India can create new opportunities for carbon finance, attracting investments and driving the expansion of clean energy projects.
The discussions also emphasised the importance of ensuring high integrity and transparency within the carbon market. Building trust among stakeholders, particularly in the international voluntary carbon market, is essential for generating carbon finance. Transparency in carbon credit transactions and stringent verification processes will be crucial in maintaining the credibility of the carbon market and ensuring it effectively contributes to India’s climate goals.
Another critical aspect covered during the workshop was the strategy for engaging buyers within the ICM. As the market evolves, it is essential to establish a robust framework that encourages participation from a diverse range of stakeholders, including industries,
financial institutions and international investors. The workshop explored various strategies to engage buyers, such as offering attractive returns on investment, raising awareness about the benefits of participating in the carbon market, and developing a clear and transparent regulatory environment.
Overall, the implementation of carbon markets represents a crucial step toward achieving emission reduction. Moving forward, refining and expanding these markets will be essential to bridging the gap between current emission levels and sustainability goals.
Akanksha Chandrakar
