How setting up its own carbon trading market can help India with its green goals

With a view to achieving net-zero carbon emissions by 2046, energy major Indian Oil Corporation had announced in August 2022 its plans to invest `2 lakh crore in phases, including purchasing carbon credits. Separately in September 2022, Indian energy sector behemoth NTPC was looking for a professional well-versed in carbon trading, who also had experience of working with carbon markets, carbon credits, carbon tax and emissions trading schemes, ESG, carbon neutrality, etc. While these are just two examples, there are many such entities that are working on such sustainability measures. But why the sudden interest?

As temperatures and greenhouse gas (GHG) emissions rise, sustainability has become a major focus area not just for regulators, but even for investors, community stakeholders, consumers, and more importantly industries, all worrying about the devastating impact of emissions on the environment. This has spurred everyone—from legacy businesses to start-ups, and regulators to policymakers—to take a serious note of their collective carbon footprint. But as some of the largest contributors to global GHG emissions, many industrial firms that are required to meet certain emission reduction targets, either by law or due to their own policies, are struggling to eliminate or even lower their carbon footprint.

It is this major gap on the road to sustainability that carbon credits are filling for companies—by helping them meet their emissions targets, or by offsetting them. This is especially true for companies working in industries such as energy, steel, cement and transportation, among others, which due to a lack of availability of technical know-how or the resources to develop them, are not able to remove as much GHG from the environment as they put in. Such firms rely on carbon trading, either by purchasing carbon credits, or by funding projects that generate carbon credits. And all this, despite the criticism of offsets.

“Carbon credits are mechanisms through which lower or no emissions of one player can be sold in a market to offset emissions of another who is ready to pay for it,” explains Hetal Gandhi, Director-Research at CRISIL Market Intelligence & Analytics. For example, if an electricity producer generates more renewable energy in a particular period than what distribution companies are ready to buy at a premium, then it is supplied as normal power, against which carbon credit certificates can be generated. These are then sold to an entity ready to buy the credits through a transaction that helps it report lower emissions, she explains. Further, these carbon credits are valued using various aspects, such as market dynamics, implementation costs or project value, along with type, size, location, etc.

T he concept of carbon credits under carbon trading came into existence in the 1990s, and as a part of the Kyoto Protocol finalised in Japan in 1997, an agreement among participating nations was reached to reduce greenhouse gas emissions. It became international law in 2005. But the market for carbon credits has only grown in recent years. Now, the global carbon credit market is estimated to be worth $414.8 billion in 2023, and poised to reach $1.6 trillion by 2028, per MarketsandMarkets Research.

During the first commitment period that ended on December 31, 2012, India, China and Brazil were three large players generating primary emission reduction instruments through registration with the United Nations Framework Convention on Climate Change (UNFCCC), under the Clean Development Mechanism (CDM) of the Kyoto Protocol. CDM is a UN-run carbon offset scheme that allows businesses from one country (developed nation) to fund greenhouse gas emissions-reducing projects in other countries, and claim the saved emissions as part of their own efforts to meet international emission targets.

During the second commitment period that started on January 1, 2013, restrictions imposed by the European Union Emissions Trading System on the trade of these instruments beyond the first commitment period resulted in a loss of demand for them from EU countries. With the Paris Agreement and subsequent decisions on Article 6 of the Agreement—that allows countries to voluntarily co-operate with each other to achieve emission reduction targets set out in their Nationally Determined Contributions (NDC)—the market is now warming up as governments initiate action based on their agreed-upon NDCs.

And India has been an active participant in the international carbon market. “Till date, India accounts for a market share of around 21 per cent of all projects registered globally under the CDM. India has channelised more than $10 billion in foreign direct investment [per a report by the Trade Promotion Council of India] under CDM till the end of the second commitment period [2020]”, explains Manish Dabkara, Chairman and MD of EKI Energy Services that is engaged in climate change, carbon credit and sustainability solutions. He adds that India has emerged as a prominent contributor to the voluntary carbon markets, exporting a substantial number of carbon credits between 2010 and 2022. “The country issued a remarkable 278 million credits during this period, representing approximately 17 per cent of the total global supply.”

But to meet India’s NDC commitment of reducing its emissions intensity (the emission rate of a pollutant relative to the intensity of a specific activity or industrial production) of its GDP by 45 per cent by 2030, the country is aggressively working on establishing an independent carbon market registry outside of the UNFCCC CDM. India is setting up its own carbon trading market and plans to have an Emissions Trading System by 2025. “We are nowhere near the amount required to enable this low-carbon economy transition. We were at roughly 25-27 per cent of the total requirements, as per CPI [Climate Policy Initiative, an advisory body], that too without factoring in new NDCs and a ‘just’ transition. The carbon markets can be used for financing this transition,” says Dabkara.

India’s carbon market will be built on the successfully operating Perform, Achieve and Trade (PAT) scheme, which is in its sixth cycle. “The designated consumers are obliged to reduce their specific energy consumption as per the targets assigned by Bureau of Energy Efficiency. In addition to this, the Renewable Energy Certificate (REC) market is also operating in parallel,” says Inderjeet Singh, Partner at Deloitte India, adding that the domestic carbon market is expected to dovetail with the existing instruments of PAT and RECs.

In addition, the Indian government has also finalised a total of 13 GHG mitigation activities, alternative materials and removal activities such as the storage of renewable energy, green hydrogen, compressed biogas, etc., that can qualify for the international trade of carbon credits under Article 6.2 of the Paris Agreement—specifically making room for bilateral arrangements between governments through internationally transferred mitigation outcomes (ITMOs). These activities will also facilitate the development and transfer of emerging technologies and mobilise international finance to India. As a result, India will have two kinds of instruments—one for domestic consumption, that is the NDC compliance requirements; and ITMOs for international trade.

There is a lack of awareness and understanding of carbon credits among businesses and organisations, making it difficult for them to identify and implement carbon reduction initiatives that can generate carbon credits, says Gandhi. In addition, the process of obtaining carbon credits is complex and time-consuming as it involves rigorous verification and validation processes to ensure that carbon reduction initiatives meet the standards set by international obligations. Adding to these challenges is the need for a clear understanding of procedures laid down in the notification for registration of projects in India under Article 6, and access to finance for opportunities that have been kept out of the purview of ITMOs.

But with the recent push from the power ministry, which unveiled a draft of the Carbon Credit Trading Scheme (CCTS), the Indian Carbon Market is starting to take shape. The Energy Conservation (Amendment) Bill, 2022—that grants the central government the authority to design such a plan—was used to introduce the CCTS. As India works aggressively towards establishing an independent carbon market registry outside the scope of UNFCC, it can gradually improve the efficiency across sectors and players, while reducing the cost of achieving the country’s NDCs, and in the long run help achieve its net-zero goals. This is also expected to drive innovation and technology advancements in the economy.

@nidhisingal