India’s proposed carbon credit trading scheme: What it is, why it matters and what to expect

Last year, the Government of India announced its intent to roll out a Carbon Credit Trading Scheme by 2026. While the National Steering Committee for the Indian carbon market is yet to announce more details, the official notice referred to a voluntary as well as a compliance-based element to the scheme.

What is carbon credit trading?

A single carbon credit represents the removal or avoided emission of one ton of carbon dioxide – or another greenhouse gas like methane of equivalent volume. These credits can be sold at a cost to an entity that can then claim that credit as a reduction in its own carbon emissions. For example, a farmer grows a tree that in theory can remove one ton of carbon dioxide from the atmosphere. The farmer then sells the carbon credit for the tree plantation to a steel company that can then claim that its “net” emissions are its original emissions minus one ton of carbon dioxide.

What is the difference between compliance-based and voluntary carbon credit trading?

In compliance-based trading, a governing institution (usually the government), sets a limit on how much carbon per unit output each member of a group can emit e.g. steel companies. If a company emits more than that limit, it is required to purchase carbon credits to bring down its net emissions to within that limit. If a company emits less than the allowed limit, it can sell the remaining allowance as a carbon credit to other companies. This creates a monetary incentive for companies to emit as little as possible.

In voluntary trading, there is no externally imposed limit on carbon emissions. Rather, a company may choose to purchase carbon credits to lower its net emissions, or even achieve net zero emission status, i.e. all carbon emissions are offset by carbon credits, out of choice. This is often because sustainability is a core value for stakeholders including customers, employees, and shareholders.

How does carbon credit trading work in practice?

Carbon credit trade has three stages – create, issue, and trade/retire.

Create

Using the previous example of a farmer planting trees - first, the farmer will plant the tree. Next, the farmer, or the project developer who hired the farmer, will conduct a Baseline Emissions Assessment (BEA), i.e. an assessment of how much carbon is being removed from the atmosphere, and prepare a Project Design Document (PDD) that includes results from the BEA as well as other details about the execution and monitoring of the tree plantation project.

Issue 

Then, an independent verifying body will validate the PDD and issue a report that confirms that the project is eligible for carbon credits. The project developer must then submit this report to a standards program that will officially issue the carbon credit and enter it in their records.

Trade/ Retire

The project developer can then decide to sell the carbon credit, for example to a steel company that wants to lower its net emissions. For this, they have to notify the standards program, which in turn will retire the carbon credit in their records, i.e. note that it has been claimed by the steel company and is therefore no longer in circulation.

If I am an aspiring entrepreneur, why should I care about a carbon credit market?

The establishment of a domestic carbon credit market unlocks multiple, potentially very lucrative, business models. Examples of business models specific to carbon-credit trade include:

• Project Developer: Create projects that remove carbon from the atmosphere or prevent the emission of carbon and sell the corresponding carbon credits at a profit.
• Baseline Emission Assessment (BEA) agency: Conduct BEA for project developers in exchange for a fixed fee or a % of profit from sale of carbon credits.
• Verification consultant: Help project developers prepare PDD and other documents to submit to a verifying body. This could either mean selling a tech tool that does this automatically or selling a service.
• Independent validation body: Charge a fee for conducting independent audits of the project and ensuring compliance with standards. It is yet to be seen however, whether the government will privatize this function.
• Carbon credit marketplace: Bring together buyers and sellers of carbon credits on a virtual platform or through a brokering service.

If I am an existing business owner, why should I care about a carbon credit market?

The private sector will be impacted by carbon credit trade in two important ways. First, if and when your sector is included in compliance-based emission trading, i.e. the government sets a limit on your emissions, you will have to reduce your emissions in line with the limit or will have to purchase carbon credits which is an added cost on your P&L.

Second, carbon credits can represent an extra revenue stream for many companies. For example: 

• Companies that use renewable energy but do not need to claim carbon emission reductions can sell the corresponding carbon credits.
• Companies that sell less carbon intensive appliances e.g. electric cookstoves or electric tractors can sell carbon credits for the carbon emissions avoided relative to the alternative.
• Companies that sell animal feed additives for ruminants that reduce methane production can sell carbon credits for the methane emission avoided.
• Companies that can cost effectively sequester carbon from the atmosphere can convert the carbon removed into carbon credits.

How much is a carbon credit worth?

While there is significant international momentum around creating a standardized price for a single carbon credit, today the price for a carbon credit is highly variable ranging from a few rupees to a few thousand rupees. As with any other tradeable commodity, the price of a carbon credit comes down to its quality. Quality in this case refers to three key aspects – credibility, durability, and existence of spillover benefits.

Credibility refers to how reliable the source of the carbon credit is. A highly credible carbon credit is one that is verified by a reputable agency, has all the necessary documentation, and can be easily and transparently monitored or proved if needed. Entities, particularly large publicly listed companies, are willing to pay more for more credible carbon credits to avoid the reputational risk of buying fake or fraudulent carbon credits.

Durability refers to how permanent the carbon credit is. For example, a tree that can in theory remove several tons of carbon dioxide from the atmosphere during its lifetime could die in a forest fire. Other sources of carbon removal such as carbon capture and sequestration (CCUS) are more permanent, and therefore their corresponding carbon credits tend to be more expensive in the open market. 

Spillover effects refer to the additional positive social or environmental benefits that can be attributed to the carbon credit. For example, several project developers in India distribute solar cook stoves to rural households to prevent them from using coal or wood-fueled cookstoves. They then sell carbon credits corresponding to the volume of carbon emission avoided from coal/wood fired cookstoves. In addition to emission mitigation, this also has health and welfare benefits for the families that receive the cookstove so a company may be willing to pay more for these credits – out of goodwill or to claim the additional benefits as their corporate social responsibility.

What are the major challenges of a domestic carbon trading scheme? 

While a carbon credit market is an effective way of incentivizing a reduction in net carbon emission and making it more cost effective, there are several key challenges that the government will have to address in the way it structures and governs the market. 

The most important challenge is that of monitoring carbon credits and maintaining oversight. Given that carbon credit projects are widespread and often in remote areas, it is difficult for a governing body to maintain oversight without relying on information from the project developer, who has a conflict of interest, or third-party verification agencies who may not always be trustworthy. 

Another key issue with carbon offsets that international markets continue to grapple with is that of additionality. In principle, a carbon credit is meant to be issued for removal or avoidance of emission which otherwise would not have occurred. This is tricky to judge in practice. For example, if solar power is cheaper than coal power in India, should a company that switches from coal to solar power be awarded carbon credits for emissions avoidance given that they would have done that any way for commercial reasons?

What can we expect India’s Carbon Credit Trading Scheme to look like?

As we wait for further indication on the ins and outs of the scheme, we can speculate based on how other countries have rolled out their domestic carbon markets and India’s contextual reality. Here are my top four hypotheses:

• The roll out will be phased starting with the power sector
• Next in line for compliance-based trading will be hard-to-abate sectors with high degrees of market concentration e.g. steel and cement
• Agricultural emissions will not see an emission cap for a long time, maybe ever
• Within an industry, the caps will be generous to begin with and will reduce over time
• Special allocations will be made for SMEs

Nirja Bhatt is a student at Harvard Business School. Previously, she studied Sustainable Development at Columbia University where she was also a Research Assistant for Climate Policy at the Earth Institute. She worked as a Strategy Consultant at Dalberg New York, specializing in renewables.