Crucial contours for operationalising the Indian carbon market need clarity

Economies globally have recognised the urgency of limiting carbon emissions to fight climate change. Putting a price on carbon emissions by developing a trading system (carbon market) to buy and sell carbon credits is one way to limit emissions. The Ministry of Power’s (MoP) recent Carbon Credit Trading Scheme (CCTS) 2023 aims at creating a domestic market for tracking and trading carbon credits. The policy is a step in the right direction for setting up India's compliance and voluntary carbon markets. Still, several questions remain unanswered on whether it operationalises the market.  

The concept of carbon credit is not new in India. The domestic carbon compliance market has existed for a long time in the form of Perform, Achieve and Trade (PAT) for tradable energy certificates (ESCerts) by designated consumers in industrial units from energy-intensive sectors such as aluminium, cement, chlor-alkali, fertiliser, iron & steel, paper & pulp, railways, thermal power and textile. The Renewable Purchase Obligation (RPO) for renewable energy certificates (RECs) by generators producing electricity from clean sources like solar, wind, biomass, small hydro and municipal solid waste is another form of carbon compliance. Further, the Energy Conservation Act 2001 also discusses issuing carbon credit certificates to registered entities.

CCTS will now encompass the existing trading mechanism by transitioning from tonnes of oil equivalent (ESCerts) to carbon certificates expressed in tonnes of carbon dioxide (CO2) equivalent.

The CCTS notification lays the framework and structure of the domestic carbon market. It constitutes a National Steering Committee comprising representatives from key ministries to govern the domestic carbon market. This committee will give recommendations to the Bureau of Energy Efficiency (BEE) for establishing emissions targets and trajectories for obligated entities under the compliance mechanism and lay guidelines for issuing and trading carbon credit certificates outside India.

Essentially, BEE will become an administrator and develop procedures and eligibility criteria for accrediting carbon verification agencies. The Grid Controller of India will handle the meta registry for obligated and non-obligated entities under the compliance and voluntary carbon markets, respectively. Meanwhile, the Central Electricity Regulatory Commission (CERC) will regulate the trading of certificates.

The Institute for Energy Economics and Financial Analysis (IEEFA) provided a series of comments in response to the draft CCTS released by the MoP in March 2023. The MoP adopted some of the suggestions, including setting up a meta registry that will be compatible with international registries, the inclusion of the non-power sector, a pathway for setting targets for emission reduction and inclusion of PAT and REC. But, the notification falls short of clarifying the operationalisation aspects, including eligible consumers, price discovery, voluntary market mechanisms and linking the domestic carbon market with the international markets to attract finance and technology.

Timeline for operationalising the market

The notification does not provide a timeline for operationalising the carbon market, including which section of the market is likely to start first. It defines obligated entities as those notified under the compliance mechanism and non-obligated entities as those that can purchase carbon credit certificates voluntarily. This definition and stakeholder consultations held by the BEE suggest that obligated entities are those that the existing PAT scheme covers. The current cycle for PAT continues until 2025. It is unclear whether the CCTS mandates all or some of these entities to transfer to the carbon credit market. As such, it will be useful to understand the timeline. Some newspaper reports discuss starting the voluntary carbon market right away. This requires clarity on the sectors and a timeline for targets and processes.

Limited specification on the sectors eligible to participate in the domestic carbon market

The notification states that the MoP will notify greenhouse gas (GHG) emissions intensity targets to the Ministry of Environment, Forest, and Climate Change (MoEFCC), based on recommendations from BEE. Obligated entities will have to achieve these targets along with any other targets, such as non-fossil energy consumption or specific energy consumption, as per the MoP’s notifications. But there is no clarity on the eligibility of the sectors and industries under this scheme. The eleven sectors identified by the National Carbon Market include petroleum refineries, cement, steel, chlor-alkali, aluminium, thermal power plants and fertilisers. Will the list expand to add more sectors? If yes, then the question is how will these additional sectors be identified.

Aligning with the existing domestic market

The Green Credit Programme (GCP) announced by MoEFCC aims to incentivise environmentally conscious practises via trading green credits. This will be a purely voluntary market covering eight sectors, primarily affecting rural areas. The sectors focus on increasing tree cover, promoting water conservation, adopting natural and regenerative agricultural practices, improving soil health and the nutritional value of food, managing waste effectively and reducing air pollution.

These activities under GCP may generate green credits and carbon credits from the same activity under the carbon market. If this is so, how are the two different? What would be the potential use of green credits if they also generate carbon credits that could be sold in the domestic market? How will the two markets intersect or overlap?

Linkages with international carbon markets

India has been participating in the sale of carbon credits through the Clean Development Mechanism (CDM) route and private sector-driven voluntary carbon market. Between 2010 and 2022, India issued 278 million credits in the voluntary carbon market, accounting for 17% of global supply, according to the Greenhouse Gas Emissions Special report by S&P Global Commodity Insights. With the domestic carbon market now in place, it is unclear whether the global carbon credit certificates will run parallel to the domestic ones.

In addition, is there a need to regulate (if yes, how?) carbon credits exported for trade in the international voluntary carbon market? Such decisions will impact India’s strategy to welcome foreign direct investment in decarbonisation activities.

Getting the pricing right for carbon credits

The effectiveness of the carbon market will depend on the accuracy of carbon price discovery. If the buying price is too high, it will deter participation, especially from micro, small, and medium enterprises (MSMEs). If the selling price is too low, there will be no incentive for real emissions reduction.

Hence, a robust methodology for price discovery and some pilots will be necessary going forward. The methodology should clearly lay out the process for price discovery based on sectoral or unit-wise emission targets. It also needs structured checks and balances to ensure market stability and prevent an oversupply or overdemand of credits.

The voluntary carbon market requires even greater efforts as price discovery is more complex considering the variety in project sizes, location, quality, value adds, and more. The scheme seems to focus on the compliance market, providing limited guidance for non-obligated entities. Enhancing private sector participation in the voluntary carbon market needs a more structured and incentive-driven mechanism.

Learnings from the global voluntary carbon market

Unlike compliance markets, voluntary markets are usually partially regulated and market-driven. Hence, multiple agencies with their own standards, eligibility criteria and terminologies exist. Offset standards, including Verra's Verified Carbon Standard (VCS) and the Gold Standard, verify the projects and ensure they follow strict rules and maintain high environmental integrity standards. However, these standards usually only assess the original offsetting project and not the broader ecosystem, allowing companies to prioritise whatever makes the most financial sense.

As India sets the foundation for its domestic carbon market, it is crucial to understand the governance structure for voluntary carbon markets. Will the National Steering Committee decide the standards, or will they remain open for the industries to take a call on? Would there be interoperability between voluntary carbon credits bought or sold in the international carbon market and the domestic voluntary market?

IEEFA welcomes the efforts taken by MoP to develop the Indian carbon market. Still, operationalising the market requires more efforts on consumer profiling, target setting, cross-ministerial coordination and robust monitoring and verification. The carbon market would help corporations become carbon neutral. In addition to the compliance market, clarity on the timeline and structure of the voluntary market is crucial considering the National Stock Exchange (NSE) and the Indian Energy Exchange (IEX) have already announced plans to explore voluntary carbon market.

This article was first published in Business Today.