Wield the stick to navigate the narrow, twisting road to net zero

The path to net zero is not just long but also likely to be a twisted, winding mountain road, full of uncertainties and expensive, risky alternatives, necessitating doubling back often, technology hopping and nimbly stepping past geopolitical disruptions.

Scientists, technologists, businesses, and politicians should lead 

The pilots for this enterprise are scientists, technologists, and businesses who must find the middle path between the conflicting objectives of least-cost transition and energy security. Politicians must lead the blind, comfort the vanquished, and tax the victorious to pay for the transition. Tax revenue to GDP ratios needs to increase well above the 16.7 percent achieved in 2022-23 (RBI) if the transition—expected to cost at least 2 percent of GDP in the first decade—is to be funded in a fiscally responsible manner. The estimate for strengthening just the Inter State Transmission System (ISTS), which constitutes a fraction of the total transmission and distribution system, is INR 3 trillion over the period 2022 to 2030 (CEA 2023).

The missing link in the government’s announced climate actions is when emissions will peak.

Inflation has been baked into the economy since July 2018. It was below the norm of 4 percent only in two months—December 2020 and January 2021. High-interest rates are here to stay, which bodes ill for the viability of risky, large investments of the kind needed in the energy transition. Most of the cost will be borne by the private sector but the government must be ready to support a just transition, which insulates those most affected by it from permanent deprivation. It should also play a leading role in financing the gap to bring nascent technologies to market, such as grid-scale batteries based on chemicals like sodium, which have an assured domestic supply chain.

The missing link—when will emissions peak? 

The missing link in the government’s announced climate actions is when emissions will peak. According to the World Bank, emissions grew at a CAGR of 5 percent  versus the real economic growth rate of 5.9 percent over 2010-2018. Extending the period to 2010-2020 reduces emissions CAGR to 2.9 percent. This is primarily because of the economic downturn during the COVID-19 epidemic. If allowed to grow unabated, emissions would more than double by 2047 and the time available to achieve net zero by 2070 will reduce by half. Post 2020, we have added 37 GW in renewable electricity capacity, which dilutes emissions growth somewhat. But much more needs to be done.

Our hand will be forced by the proactive climate stance of the European Union (EU), which plans to impose a carbon border tax on all imports from 2026. Other developed economies might follow.

There is a trade-off between the high costs of an early transition to reap the benefits of lower cumulative carbon emissions and acquire the first mover advantage in hydrogen. To achieve this, the performance metric is early peaking of emissions by the 2030s. A late transition, with emissions peaking in the 2050s, prolongs business as usual. But the headwinds will be challenging. First, we aim to be the third-largest economy by 2047 and surely that entails accepting significant climate responsibility. In fact, our hand will be forced by the proactive climate stance of the European Union (EU), which plans to impose a carbon border tax on all imports from 2026. Other developed economies might follow. Unless our metal products are decarbonised, they will be uncompetitive for developed markets. One way out of this conundrum is to impose a domestic carbon tax on coal and petroleum and subsume all the taxes presently levied on them by the union and state governments.

The trade-off between a carbon tax and emissions trading 

The advantage of imposing a carbon tax—even if it brings no net revenues to the government—is the certainty of revenues and the explicit nature of the levy, which lends itself to an easy set-off for exports against the border carbon taxes of other jurisdictions. The downside is that the revenues are likely to be used for general purposes rather than reserved for financing the energy transition. Also negotiating this new tax with the state governments—which would lose their existing right to tax the sale of petroleum products—could be protracted like the GST negotiations were. The option which the government has already chosen is to apply the existing format of the Perform Achieve Trade scheme for energy efficiency to carbon emissions. Emissions standards will be determined—for each industry or across a set of industries—and tradable emissions certificates will be issued to those performing better than the prescribed standard. The industry would provide the demand for these certificates.

The option which the government has already chosen is to apply the existing format of the Perform Achieve Trade scheme for energy efficiency to carbon emissions.

Industry is a prime user of coal. Low-carbon alternatives, like green hydrogen, are much further away than renewable alternatives to coal-based electricity. Carbon Capture and Use or Storage (CCUS) remains expensive, use options are limited, and storage locations scarce. It is pragmatic to focus government support on renewable electricity and encourage the private sector to take the lead on developing green hydrogen and CCUS eco-systems to avoid buying the certificates. Reliable, cheap renewable electricity (RE) supply is the primary input into the manufacture of green hydrogen via electrolysers which are energy-hungry—one ton of green hydrogen requires 50 MWh of renewable electricity. Although the government has already provided incentives, only material and process efficiency in electrolysis can reduce the cost of green hydrogen to affordable levels which can be expected only post-2030.

Unmasking the cost of carbon 

One of the benefits of unmasking the cost of carbon is that the ultimate customer or the intermediate manufacturer has to pay for it, throwing much-needed light on the cost of carbon. Once market prices for carbon exist, they feed into cost-benefit-based decisions. Consider that the real cost of putting up 50 GW of new coal capacity, as planned by the government, will increase significantly if the power sector becomes obligated to reduce carbon emissions or buy emission certificates. This might induce the government to shut down loss-making coal mines—most of which are underground. By letting them linger, land assets, which could be monetised and create new jobs, are left unutilised.

Carbon Capture and Use or Storage (CCUS) remains expensive, use options are limited, and storage locations scarce.

Using fiscal allocations to maximum effect 

Presently, the government is focused on incubating scaled-up RE by using the balance sheet of Solar Energy Corporation of India (SECI)—a publicly-owned company—to bear the risk of payment default by financially challenged Discoms (distribution and retail supply companies). Of these, all 12 private and 18 out of 56 publicly-owned discoms are profitable. Sadly, all discoms are reliant on the timely payment of tariff subsidies by state governments to remain profitable. This tars them all with the same brush as high-risk buyers of power. SECI has been tasked to buy all the solar and wind power generated by private companies and enter into power sale agreements with distribution companies. This makes growth in RE hostage to the limited fiscal risk appetite of the Union government. An suitable arrangement, in the very near-term, is clearly not available if 1,500 TWh of solar and wind electricity worth around INR 7 trillion is to be traded by 2045.

Weaning RE capacity growth off the crutch of government guarantees is directly related to disciplining discoms to improve their credit risk rating. Discoms responded to the hard budget line imposed by the Ministry of Power to levy a surcharge on late payments by Discoms to generators. Persistent default led to a reduction of grid supplies. The result—payables to generators are down from INR 1.39 trillion in June to INR 0.27 trillion by the end of October 2023.

SECI has been tasked to buy all the solar and wind power generated by private companies and enter into power sale agreements with distribution companies.

Applying carbon pricing to the power sector 

Clarity is also necessary on the role of natural gas in the energy transition. The plan is to subsidise 40 percent of the cost of storage via a viability gap funding mechanism since storage is critical for RE capacity growth. The problem with Battery Energy Storage Systems (BESS) is the reliance on imported batteries with dominant Chinese control over lithium and graphite refining. These two key imported battery ingredients already violate the “own shoring” energy security metric. Instead, using imported natural gas for grid support, till prices decline for BESS, would be pragmatic. The idling gas generation capacity of 25 GW can support 500 GW of variable RE. This can be achieved if carbon pricing-based obligations are applied to all power generators. Coal-based generators would need to buy emission certificates to compensate for their excess emissions. In contrast, solar, wind and gas generators would earn carbon emission credits to reflect their low carbon supply.

This could be a market-oriented solution to avoid the well-known limitations of an active industrial policy with the government choosing the winners. The resultant increase in the retail price of power should be neutralised by improved performance parameters in the discoms under the Union government’s flagship Revamped Distribution Sector Scheme (RDSS) worth INR 3 trillion. Discoms have responded to hard budget constraints on timely payments for grid power supply. Enough carrots have been used, it is time to wield the stick.

Sanjeev Ahluwalia is an Advisor at the Observer Research Foundation.