Expert Speak Terra Nova
Published on Jan 10, 2024

Indian enterprises stand at the threshold of a lucrative venture, tapping into the thriving global carbon trading markets. These entities also play a pivotal role in curbing India's emissions.

Carbon trading in India: Local actions for the global commons

The United Nations Framework Convention on Climate Change’s (UNFCCC) strategy for global carbon emissions reduction has undergone a sea change since the 2015 Paris Agreement. While the earlier dispensation of the Kyoto Protocol with a commitment period from 2008 to 2020 mandated only the Annex-1 or developed countries to reduce their emissions as per the set targets, the new “global climate order” with the onset of the Paris Agreement witnessed other participating countries agreeing to reduce emissions albeit without globally mandated targets. Without setting binding targets, the Paris Agreement acknowledged the principle of common but differentiated responsibilities based on the capabilities and bandwidth of the nations to reduce their emissions. This therefore is based on a consensual mechanism in which all the countries, developed and developing, are expected to declare intended NDCs every five years beginning in 2020 (countries could revise their commitments in-between but only upwards). The effectiveness of the Paris Agreement hinges on moral suasion and “naming and shaming”.

India has made ambitious NDC commitments. Some of them, like achieving 50 percent cumulative electric power installed capacity from non-fossil fuel-based energy resources by 2030, are definitive and measurable. What about the commitment of reducing the emission intensity of India’s GDP by 45 percent by 2030 over 2005? Is there a credible and monitorable action plan in place to achieve this target as per the agreed timeline? The efficacy and impact of mitigation efforts through nature-based solutions like afforestation, or transition projects like Electric Vehicles (EVs) or renewable energy for meeting these targets of emission intensity of GDP is yet to be known and deserves an ex-ante analysis. As such, though the government has a host of emission reduction plans, many of them are neither quantifiable nor monitorable.

Without setting binding targets, the Paris Agreement acknowledged the principle of common but differentiated responsibilities based on the capabilities and bandwidth of the nations to reduce their emissions.

To do that, there is a need to place certain data in the public domain, namely, the GDP projection for 2030, the growth drivers under various energy scenarios, and the methodology. The carbon intensity of GDP may then be worked out under various energy mix scenarios.

 Given the emerging projected chasm between the aforesaid estimated emission intensity of GDP and the NDC commitment numbers, sector-specific GHG emission targets can be fixed, including for the relatively emission-intensive sectors like steel, aluminium, cement, thermal power sector, etc. These quantitative targets may be fixed based on global best practices in each of those sectors, but adopting them as per domestic capabilities. The projected reduction in emissions, assuming achievement of these targets, may then be taken into account, while estimating the total emission intensity reduction by 2030.

The need and emergence of carbon trading in India

The eligible entities in identified sectors should be mandated to meet the prescribed targets. For example, if on average, the steel production currently emits 2.5 tonnes of CO2 equv./ tonne of steel production, and the target works to bring it down to 1.7 tonnes of CO2 equv. by 2030 in a phased manner, each eligible entity producing steel of that specification, will need to follow that phase down. The period up to 2030 may be divided into time blocks, with a target fixed for each block. Any entity unable to meet those targets could purchase carbon credits from some other entity that over-achieves the target, to meet its obligations. One carbon credit will be equivalent to one tonne of CO2 reduction. This definition of carbon credit may be sector-agnostic amongst all the mandated sectors. The carbon credit trading mechanism, with a suitable regulatory mechanism in place, should help in the planned decline of carbon emissions in a cost-effective manner.

Emissions trading remained virtually a non-starter in developing countries under the Protocol, as the emissions reduction mandate was applicable for Annex-1 nations.

The criticisms of the Kyoto Protocol’s “cap and trade” mechanism are, by now, well known. Emissions trading remained virtually a non-starter in developing countries under the Protocol, as the emissions reduction mandate was applicable for Annex-1 nations. However, many projects in emerging economies including India complied with and participated in the voluntary global carbon credit market under the clean development mechanism (CDM). This mechanism came in for criticism, for the right reasons, due to various shortcomings and anomalies, including double counting of emission reduction in the host country as well as the foreign country, and taking undue credit. Though COP26 has opened the opportunities for creating a global carbon market, much needs to be done to have a well-functioning international carbon trading market.

Notably, the Government of India has taken a welcome step by notifying the Carbon Credit Trading Scheme (CCTS) on 28 June under the Energy Conservation Act, 2001. The scheme entails setting GHG emission intensity reduction targets for entities in selected sectors. The scheme aims to develop a regulated domestic carbon credit trading market, with transparent price discovery. The Bureau of Energy Efficiency (BEE) has a key role in administering the scheme and formulating the targets for the obligated entities under the scheme, and the Central Electricity Regulatory Commission (CERC) regulates the trading of carbon credit certificates.

The CCTS notification provides a broad framework. Much more detailing needs to be done for the scheme to take off. For instance, questions remain about which sectors would be covered (obligated entities) under the scheme, the criteria for selecting such sectors (entities), the methodology for disaggregating the overall national level NDC GHG emission targets at the sectoral and entity level; the envisaged mechanism for monitoring, reporting and verifying GHG emissions; and the criteria for issuing carbon credit certificates, including their validity period.

The Bureau of Energy Efficiency (BEE) has a key role in administering the scheme and formulating the targets for the obligated entities under the scheme, and the Central Electricity Regulatory Commission (CERC) regulates the trading of carbon credit certificates.

 The category of eligible participants in the proposed CCTS, as also its scope, needs to be increased—as of now, it appears to be a mere extension of the PAT (perform, achieve and trade) scheme of BEE. The financial institutions, banks, and traders should be allowed to participate to provide liquidity and help in better price discovery. The scheme’s scope should be extended to cover GHG emissions from sources/activities beyond the energy and industry sector to include agriculture, forestry and land use, transportation, airlines, waste management, and carbon capture and storage. Futures trading in carbon credits may be allowed on commodity derivatives trading exchanges. The BEE and CERC, with their mandate limited to the power sector, may not be the right agencies to develop the carbon trading framework in India. This brings us to the discussion about an autonomous and specialised regulator for carbon trading.

Market efficiency

An important aspect that needs to be discussed and debated is India’s participation in the international carbon trading market, and whether export of carbon credits should be allowed at this stage. This will require product innovation and fungibility. On the other side, international participation including those of FIIs should be thought of in the derivatives segment of the carbon markets. The advantage is that they will help in bringing in sufficient liquidity in the market, and help in hedging and price discovery. The flip side of the story lies in the fact that this can prove counterproductive with excessive speculation. From another regulatory perspective, Indian regulation should be in sync with international regulatory norms so that the possibility of regulatory arbitrage is minimised.

The flip side of the story lies in the fact that this can prove counterproductive with excessive speculation.

The most critical parameter to gauge market efficiency is that at the national level, the carbon credit price should reflect the social cost of carbon. The social cost of carbon (SCC) is an estimate of the monetary cost of the damage caused by an additional unit of carbon emissions. This will again depend on the information and knowledge of the concerned stakeholders. Regulators have an important role to play here in capacity building.

To infer…

Indian enterprises stand at the threshold of a lucrative venture, tapping into the thriving global carbon trading markets, where the stakes and prices are notably higher in developed regions, promising a robust future. Yet, it's not just about profits—these entities bear a pivotal role in curbing India's own emissions. The crux lies in balancing local responsibilities with global opportunities: Should Indian players dive into international markets, and should we welcome foreign buyers for our carbon credits? A blanket ban risks missing out on establishing a global foothold, a task that requires time and trust. The savvy move? Chart a clear course towards our National Determined Contributions (NDC) goals first. Then, in a carefully measured, phase-by-phase approach, open the doors to carbon credit exports, all while keeping an eagle eye on international dynamics. This is not just trading; it's strategic global engagement with an eco-conscious twist. 


Ajay Tyagi is a Distinguished Fellow at the Observer Research Foundation 

Nilanjan Ghosh is a Director at the Observer Research Foundation

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Authors

Ajay Tyagi

Ajay Tyagi

Ajay Tyagi specialises in the financial sector especially the capital markets. He has also worked extensively in the environment and energy sectors. He served as the ...

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Nilanjan Ghosh

Nilanjan Ghosh

Dr Nilanjan Ghosh is a Director at the Observer Research Foundation (ORF) in India, where he leads the Centre for New Economic Diplomacy (CNED) and ...

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