This article provides international background and summarises recent updates leading to the proposed development of carbon markets in India
Introduction
Sustainability and climate change have become an increased focus area for investors, companies and governments all over the world. The Indian Government has also stepped up its efforts, committing higher reduction in the emissions intensity and increase in non-fossil fuel-based energy resources by 2030, in the revised Nationally Determined Contributions (NDCs).
India's NDCs, submitted as part of the Paris Agreement in 2015, were updated by the government in Aug 2022:
Emissions intensity is defined as the total amount of greenhouse gas (measured in kg CO2e) emitted for every unit of GDP (in INR). Earlier, India had set a target of reducing emissions intensity of its GDP by 33-35% by 2030 from 2005 level. This target is now increased to 45%.
Further, the earlier commitment for cumulative electric power installed capacity from non-fossil fuel-based energy resources was 40% by the year 2030. This is now increased to 50%.
To reduce the carbon emissions, it is important to incentivise high-polluting industries for reducing their emissions and develop a mechanism to channelise adequate funds for investing into environment friendly projects. One mechanism for achieving this is the system of carbon credits, which are tradeable at carbon markets.
Global Developments
The concept of Carbon Credits was first introduced under the UN Kyoto Protocol (along with Marrakesh Accords) which mandated 37 industrialised nations and the EU to cut down their greenhouse gas emissions. Under this, carbon credits could be accrued in three ways:
Clean Development Mechanism (CDM): developing countries would accrue Certified Emission Reduction (CER) credits through greenhouse gas emissions reduction projects. The CER could be purchased by industrialised nation to meet their own emission targets, effectively allowing these nations to fund develop countries’ emissions reduction projects.
Joint Implementation: industrialised nations earning Emission Reduction Units (ERUs) by investing into emission reduction / emission removal project in another industrialised nation. The ERUs are counted towards meeting emission targets.
International Emissions Trading (IET): industrialised nation selling its unused allowed emissions (referred to as assigned amount units (AAUs)) to other nations that exceed their AAUs.
CDM and Joint Implementation were offsetting mechanisms while IET was a trading mechanism.
While the Kyoto Protocol was adopted in 1997, it became operational in 2005, with its first commitment period ending in 2012. The Kyoto Protocol was succeeded by the Doha Amendment which had a very short life, since it entered into force in 2020, the same year when the second commitment period ended.
The Paris Agreement of 2015 adopted during COP 21 marked a major shift by requiring developing countries as well to address climate change, through non-binding NDCs. Article 6 of this agreement allows countries to cooperate with one another in achieving their respective NDCs by way of:
Internationally Transferred Mitigation Outcomes (ITMOs): Article 6.2 builds up on International Emissions Trading (IET) of the Kyoto Protocol and refers to framework for implementing ITMOs between countries or governments, tradeable through bilateral or multilateral agreements. A country that overachieves its climate targets can transfer ITMOs or carbon credits to another country. The rules approved in COP26 also require “corresponding adjustments” to ensure that each carbon credit counts only towards one country’s climate targets, thus avoiding double counting.
Sustainable Development Mechanism: Article 6.4 is the planned mechanism to replace Clean Development Mission (CDM) and Joint Implementation under the Kyoto Protocol with sustainable development mechanism (SDM). The SDM will a carbon offsetting mechanism involving public and private entities generating carbon credits from specific emissions avoidance or removal activities. These credits then can be utilised towards: meeting international mitigation purposes (ITMOs), or for mitigation contribution in the host country. Sustainable Development Mechanism is also referred to as Global Carbon Market Mechanism (GCMM) by some authors.
Non-market approaches: Article 6.8 refers to non-market approaches, which would cover international cooperation for climate initiatives, roadmaps, knowledge sharing / technology transfers, etc. among governments. These do not involve any trading or transfer of emissions.
The implementation of Kyoto Protocol in 2005 led to development of carbon markets, which are categorised as:
Compliance Carbon Markets: There are two types – the most common one is Emissions Trading Systems (ETS) or cap-and-trade programmes. These are created by mandatory regional, national or international carbon reduction regimes. In this, governmental organisations issue carbon emission allowances (as a ‘cap’) for domestic firms and sectors, mandating maximum allowable carbon emissions. The unused ones can be sold or traded by emitters or financial intermediaries. There is another type of carbon compliance market – baseline-and-credit system. In this, there is no fixed limit on emissions, however emitters that reduce their emissions beyond what they would otherwise be obliged to earn credits that they can sell to those who need them.
Compliance Offset Market: The United Nations acts as the supervisory authority for these. The Clean Development Mechanism under the Kyoto Protocol and now under Article 6.4 of Paris Agreement fall under this category.
Voluntary Carbon Markets: These are not legally mandated but are self-governed by participants. Organisations with operations that avoid / remove a unit of carbon (1 CO2e ton) from the atmosphere generate ‘carbon offset’, which can be purchased by other organisations looking to reduce their own carbon footprint. There are two main ways of generating carbon offsets: reduction / avoidance projects (installing solar power plant instead of coal power plant) and removal / sequestration projects (carbon capture, use and storage (CCUS), direct air capture, reforestation).
The major compliance carbon markets are EU ETS, California Global Warming Solutions Act and China National ETS. Some other markets are the Korean ETS, the Japan ETS, New Zealand ETS, etc.
The rules to implement Article 6 of Paris Agreement were approved in COP26 (held in Oct-Nov 2021), which provide:
accounting guidance to avoid double counting (corresponding adjustments),
how a country would measure, report and verify (MRV) progress towards its climate targets,
demonstrating ‘additionality’ for activities under sustainable development mechanism,
credit periods for removal projects and avoidance projects,
carry over of carbon credits from CDM projects, etc.
In COP 27 held in Nov 2022, some more clarity was achieved on the rules for Article 6:
Confidentiality obligations under Article 6.2
New type of carbon credit was proposed known as Article 6.4 mitigation contribution emission reduction (MCER), “primarily for results-based climate finance, domestic mitigation pricing schemes, or domestic price-based measures, for the purpose of contributing to the reduction of emission levels in the host Party”. These could be tradeable under voluntary carbon markets, indicating that corporates’ contribution to achievement of NDCs.
Countries have already started executing agreements under Article 6.2. Singapore has signed agreements with 5 countries and negotiating with 15 more, Sweden has signed MOU with Nepal and Ghana, Switzerland has signed the most deals. Further clarity regarding certain issues would come in the future, such as legacy credits under CDM and transfer to Global Carbon Market Mechanism (GCMM) under Article 6.4, operations of GCMM registry, etc.
Carbon Market in India
In India, the carbon market has existed in the form of two programmes:
Perform Achieve and Trade (PAT) scheme under the National Mission for Enhanced Energy Efficiency (NMEEE), under the Energy Conservation Act, 2001.
The PAT scheme mandates specific energy consumption (SEC) improvements for the most energy intensive sectors, through accelerated adoption of efficient and low-carbon technologies. PAT scheme is implemented in cycles of 3 years each, where the Designated Consumers (DCs) are assigned SEC reduction targets. The performance is then verified by third party agencies, post which the issuance or purchase obligations of tradable Energy Saving Certificates (ESCerts) is determined. Starting with 2012, total 7 cycles of PAT have been launched till date. The scheme is implemented by the Bureau of Energy Efficiency (BEE) under the aegis of the Ministry of Power. The trading of ESCerts is regulated by Central Electricity Regulatory Commission and the trading occurs at the end of each PAT cycle at power exchanges – India Energy Exchange (IEX) and Power Exchange India Limited (PXIL).
Renewable Energy Certificate (REC) is market-based instrument issued to the bearer certifying one MWh of electricity generated by renewable source. The REC mechanism was launched in 2010 to provide flexibility to obligated entities to achieve renewable purchase obligations (RPOs) in a cost-efficient manner. RECs were introduced by the CERC under the Electricity Act, 2003 and these are also tradable at the power exchanges. In Sep 2021, the REC mechanism was revamped to address REC validity periods, removing floor and forbearance prices, etc. The obligated entities are electricity DISCOMs, open access consumers and captive power producers.
The Energy Conservation (Amendment) Act, 2022 received the assent of the President of India in Dec 2022 and has become effective from 01 January 2023 onwards. It empowers the Central Government to specify a carbon credit trading scheme, wherein the government or any authorised agency may issue carbon credit certificates. Further, any person other than designated consumer can also purchase carbon credit certificates on voluntary basis.
The amendments are introduced to overcome existing barriers in the ESCerts and REC schemes: limited participation by only designated consumers (DCs), limited trading period, compatibility challenges due to units of trading and international voluntary carbon market standards. BEE is slated to be the administrator, formulating the complete framework, setting the systems and methodologies for both voluntary and compliance markets. While the overall framework and the voluntary market are expected to be rolled out in 2023, the compliance market is expected to take 2-3 years. PAT scheme would be transitioned to the compliance market.
In Oct 2021, the Bureau of Energy Efficiency (BEE) prepared a draft blueprint for stakeholder consultation for developing National Carbon Market in India. As per the draft, a voluntary carbon market (VCM) would be developed using the PAT scheme in 3 phases:
Phase 1: Increasing demand in the VCM. Encouraging demand for ESCerts and RECs by focusing on making the instruments more fungible, adding more participants including voluntary buyers to the pool, changing the trading period (from 3 years to one year) and linking other markets. Airlines and airport operators are also envisaged to be brought into VCM, in line with The Carbon Offsetting and Reduction Scheme for Aviation (CORSIA) developed by the International Civil Aviation Organization (ICAO).
Phase 2: Increasing supply in the VCM. Post completion of Phase-1, the supply side would be augmented through project level registrations and their proper validation, verification and issuance of emission reduction units (ERUs). Project would be required to go through rigorous process to ensure that real, quantifiable emissions reductions have been achieved. They will have to demonstrate that the social and environmental benefits exceed business-as-usual emissions reductions, which would be validated by third-party auditors. Post implementation, these would be required to be verified by auditors to assess GHG mitigation and the developer can issue tradable credits.
Phase 3: Moving to cap-and-trade system. In this, sectors and within each sector, specific companies would be earmarked for specific amounts of emission. Each entity would need to setup GHG emissions inventory and MRV (monitoring, reporting and verifying) scheme. Entity-specific GHG emission intensity factor would be determined (such as CO2e t / MWh electricity output). Expected sectoral growth over next years would be used for projecting BAU (business-as-usual) emissions, which will then be aligned with the Indian NDC using coefficient or competitiveness situation or abatement cost/potential. Credits will be based on actual production volumes compared with NDC-aligned targets.
Way Forward
In May 2022, the Government of Gujarat also entered into strategic partnerships for setting up India’s first carbon trading market. This develops on the ETS pilot project in Surat which was launched in Sep 2019 for particulate matter pollution. Further, one of the power exchanges – India Energy Exchange recently announced setting up of a wholly owned subsidiary, International Carbon Exchange Pvt Ltd, to explore business opportunities in the voluntary carbon market. The amendments in the Energy Conservation (Amendment) Act usher in the requisite legal mandate for development of carbon markets in India.
All these measures are expected to provide greater flexibility to companies in hard-to-abate sectors in a cost-efficient manner. The WTO has also called for a global shared carbon pricing framework and development of carbon markets will lead to better price determination of carbon. As the pricing improves, companies will be incentivised to adopt technological innovations for energy efficiency and climate improvement. This would also help prepare Indian exporters for EU’s Carbon Border Adjustment Mechanism (CBAM) (also called as Carbon Border Tax), set to be effective from 2026.
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