‘A voluntary carbon market won’t have a significant impact on India’s emissions’

India outlined its plans for a national carbon-trading market last month. CarbonCopy spoke to Gilles Dufrasne and Jonathan Crook of Carbon Market Watch (CMW) on what lessons India could learn from the global carbon market space before it locks in on its strategy

On August 8, the Lok Sabha, the Lower House of the Indian Parliament, passed the Energy Conservation Amendment Bill, 2022. This bill, when it comes into force, will replace The Energy Conservation Act, 2001, with new norms and standards.  

Along with mandating a minimum use of non-fossil fuel sources for industries, the bill also advances India’s plan to create a national carbon-trading market. The market, in its initial phase, reportedly, will focus on major polluting industries, including cement, steel and power.  The bill will be tabled in the Rajya Sabha in the winter session of the Parliament.

There is very limited information available on public platforms regarding how the market will be set up. Various features of the market, including a national credit registry and standards, are still to be worked out and put in the public domain. According to the latest information, to set up the market, the Bureau of Energy Efficiency (BEE) has tendered PriceWaterhouseCoopers (PwC) to undertake the launch.

In the absence of granular details, a draft carbon market blueprint published by the power ministry provides some insights. As per the draft:

• The market will be “cost effective, politically feasible and … based on the existing body of knowledge of managing ESCs [Energy Savings Certificates] and RECs [Renewable Energy Certificates] transactions.” 
• The new market will subsume ESCs and RECs–currently traded on power exchanges using the Perform Achieve and Trade (PAT) platform–and create a common one-stop-shop for credits with a “meta-registry”. The draft says, “Such a carbon market would help create synergies across different policy measures for climate change mitigation, by creating a common marketplace for emissions trading through the development of a meta-registry”.
• The market will be introduced in three phases. Phase one would focus on increasing demand, making ESCs and RECs more fungible (or interchangeable), adding participants to the buying pool and linking other markets to a ‘voluntary carbon market’.
• Demand would stem from voluntary buyers, designated consumers in the PAT programme representing 50% of India’s primary energy consumption, state-designated agencies, distribution companies that have renewable purchase obligations, and airlines.
• Phase two would focus on increasing supply in the market. As per the draft, the crucial supply-side push would come from project-level registration and proper validation, verification and issuance of emission reduction units (ERU). Participants’ activities would be credited with a project-specific reference case. For emissions reduction activities, this would be done by applying a greenhouse gas intensity factor to the production in question. The performance of the activity will be monitored and respective amounts of credits will be issued by the regulatory body. In order to generate credit, a project developer must complete a rigorous process in order to ensure that real, quantifiable emissions reductions have been achieved.
• The third and final phase sees the market entering into a cap-and-trade regime where sectors and specific companies are allotted emissions quotas, with an overall emission cap. Companies that can easily abate their emissions will do so and sell their extra cuts to the companies which could not cut their emissions. To set a baseline for the first crediting period of the program, sectoral growth in the next few years would be used. Eventually, the targets will be aligned with India’s net-zero pledge.
• To participate, each entity would need to set up a GHG emissions inventory and a monitoring, reporting and verification system.

What are ESCs? 
Under the Indian government’s Perform Achieve and Trade (PAT) scheme, Energy Saving Certificates (ESCs) are issued to those plants that have achieved excess energy savings over their targets. Units that are unable to meet the targets either through their own actions or through the purchase of ESCerts are liable to financial penalty under the Energy Conservation Act, 2001]

What are RECs?
Renewable Energy Certificates (RECs) are market-based instruments that certify the bearer owns one megawatt-hour (MWh) of electricity generated from a renewable energy source. The REC received can then be sold on the open market as an energy commodity once the power provider has fed the energy into the grid. RECs are traded by all electricity distribution licensees in India to meet their Renewable Purchase Obligation (RPO) which mandates them to purchase or produce a minimum specified quantity of their requirements from renewables.

There are, however, some lessons from India’s experience with the PAT scheme that entails reducing fossil fuel-based energy use in 13 energy-intensive sectors, including thermal power plants, cement, metals, fertilisers, petrochemicals, and textiles. The government claims its success, but after finely combing through the scheme and its performance a 2021 study by a Delhi-based think tank, the Centre for Science and Environment (CSE) found the results less enthusiastic.

With an example of the power sector, CSE analysis shows that the total emission reduction at the end of completed first two PAT cycles–6 years in total, 3 years each–from the thermal power plant sector is 24.85 million tonnes of CO2, which is only 3% of the total annual emission from the sector. So, “the achieved annual emission reduction is very feeble,” the study said. The study also pointed out how an excess of availability of ESCs led to cheaper prices. Buying ESCs for compliance was far less expensive for thermal power plants than demonstrating compliance by installing energy-saving measures.

The problem is one of standardisation. With different methods and efficiencies of the emission reduction process applicable for different industries and production processes, how can it be ensured that Emission Reduction Certificates (ERCs) awarded represent the same effective quantity or quality of emission reductions. The methodology used to measure these reductions will thus be critical. If the applied parameters are too lax, it might lead to a flood of ERCs that cumulatively account for low levels of real emission reduction while also undermining the market through an oversupply of credits. If the parameters are too tight, on the other hand, the number of ERCs issued could become too low to sustain a healthy functioning market that represents real emission reductions.

These will also have a bearing on the price of these credits, which will be a key determinant of the effectiveness of the market in terms of real emission reductions. If priced too low, industries will find it easier to buy credits than achieving any real emission cuts. If the cost of purchasing credits is prohibitive, it might lead to low industry participation and the pricing-out of smaller players from the market.  

India’s carbon market will be ‘voluntary’ in its intermediate phase, and these markets around the world typically function under skeletal regulation. They often lack robust governance structures including standards for permanence and additionality. There are questions about their efficacy to achieve legitimate emission cuts. 

These initial stages of building demand and establishing a voluntary market, however, will be followed by a cap-and-trade regime, similar to the European Union’s Emissions Trading System (EU-ETS), which is grappling with its own set of challenges including generous allocation of pollution quotas to industries, which essentially served as a subsidy to polluters.

To understand these larger issues and learnings in the carbon market space from around the world, CarbonCopy spoke with carbon market experts Gilles Dufrasne and Jonathan Crook of Carbon Market Watch (CMW), an international non-profit. 

Excerpts of the interview:

The blueprint sees a market introduced in three phases, moving from building demand in a voluntary system, then supply before a final cap-and-trade phase. Are there examples like this around the world? What are your initial thoughts on this?

I am not aware of similar examples in place today. CORSIA—a carbon market for airlines, set up at the United Nations level—similarly starts with an offsetting requirement for airlines, but it’s unclear that it will ever evolve into a cap and trade system. Some existing cap-and-trade systems started with very generous allocations of pollution permits (like the EU-ETS) before progressively becoming more stringent.

A voluntary system is unlikely to have any significant impact on emissions. The carbon price will likely be very low—because carbon credits on the voluntary market are very cheap, and hence is unlikely to incentivise meaningful reductions within companies. At the same time, there is a real risk that the credits purchased will not represent the full tonne of CO₂e [carbon dioxide equivalent] that they are supposed to represent because many voluntary market projects issue credits of low quality (one major problem being the lack of additionality).

The third and final phase focuses on moving to a cap-and-trade system with sectors and specific companies being allotted emissions quotas. India’s cap-and-trade design is somewhat similar to the EU’s. What are the checks and balances that India should be careful about going forward? Any shortcomings in the EU market that India can learn from?

There are some valuable lessons to be drawn from the EU’s experience.

First, the EU has distributed too many allowances to companies, which has created a large oversupply that continues to weaken the system up to this day.

Second, the EU distributed a very large share of these allowances for free to industry—instead of auctioning them. This means that European governments have lost significant revenues from the sale of these allowances. Such a system also fails to implement the “polluter pays principle”, and in fact actually ended up subsidising the heaviest polluters, as they received more permits than they needed, and were able to sell these on the market and make a profit. Even without this overallocation, to this day, companies continue to pass on the cost of allowances to consumers, despite not having to pay to acquire them in the first place, which creates significant “windfall profits” for these companies.

The reduction trajectory under the EU ETS has also been too weak for years and continues not to be in line with the EU’s objective of reaching net-zero by 2050. This trajectory is currently being renegotiated, but substantial industry lobbying has, over the years, significantly weakened the stringency of the system.

What are the larger risks around such markets that you have seen worldwide? 

Cap-and-trade systems can be an impactful climate tool. When implemented correctly, they can set a meaningful decarbonisation incentive by pricing carbon, while at the same time generating large public revenues, which could for example be used to finance decarbonisation efforts or balance any social impacts from the carbon pricing policy. To achieve this, it is important to avoid the pitfalls of free allocation and over-generous distribution of allowances, which industries will certainly promote.

A voluntary market, on the other hand, is unlikely to make a significant difference in emissions. A significant share of voluntary market projects is not additional, meaning that these are projects which would go ahead regardless of the sale of carbon credits. A company buying such credits hence does not finance climate action, but simply hands out money to a project that would have happened anyway. Many renewable energy projects, in particular, larger ones and/or those connected to the grid, fall under this category of non-additionality. The credits generated by these projects are not only of low quality, but they are also very cheap. This gives companies an easy alternative to reducing their own emissions, which can have long-term impacts by locking them into high carbon investments.

In general, in systems like this, what are the basic standards and regulations for voluntary and cap-and-trade systems that should be in place to protect against greenwashing or unintended uses?

Avoid excessive distribution of allowances: It is key to respect a few basic principles, in particular, the implementation of the polluter pays principle. While a voluntary market is unlikely to have a significant impact, a cap and trade system can raise large public revenues, while setting a real incentive to decarbonise. A priority should be to avoid excessive distribution of allowances and ensure the auctioning – rather than free distribution – of allowances.

A registry should ensure independently verifiable transactions: Further, when and if a registry is set up for the baseline-and-crediting system it should have enough information for independent parties to be able to verify what’s happening, and what transactions are occurring. There should be rules about disclosures in the registry, which will ensure information about who is holding credits, on whose behalf, when it’s sold, to whom it is sold, and how much of the revenue is going back to the product developer or to local communities, where relevant. This is something sorely lacking from voluntary carbon markets currently. There are different entities that track how many credits have been issued, retired, etc. But there’s almost no information about who’s holding credits. This leads to a situation where intermediaries can hold millions of credits without anyone knowing.

All of this information is important because, for example, there are cases of LNG-cargoes being marketed as ‘carbon neutral’, because they have supposedly purchased carbon credits to offset the emissions. Aside from the fact that this is completely misleading for many reasons (including that Scope 3 emissions are not always accounted for), they often don’t disclose which credits, from which project. In this case, if oil and gas companies don’t voluntarily disclose it, and if it’s not required by law to publicly disclose this information on the registry, then there’s no way of verifying the claims about these offsets. 

Ensure strong safeguards for communities: Another very important thing for India would be to ensure that there are strong safeguards for people and communities at the local level that may be involved, or associated with a carbon crediting project. Many voluntary carbon market projects do not have a lot of transparency in terms of how many benefits local communities will receive from a project. Some standards may require a benefit-sharing agreement with the community, though they are not usually made public. As a result, it’s hard to actually know what’s happening on the ground. There have been cases reported, even recently, of brokers who resold carbon credits at a higher rate, as the price of carbon credits increased, but seemingly without any of the additional benefits going to the product developer or to local communities. So that’s a huge problem. Ideally, having a government setup system could help to mitigate some of these issues by making it a requirement, for instance, for brokers to disclose what percentage of the revenue goes to the project, developer, communities, etc, to have robust safeguards in place.