The power minister, last month, announced the clearest move yet to start incorporating a price of carbon in goods and services generated in India.

Navigating the minefield of India’s imminent carbon market

The recent amendment to the Energy Conservation Act lays the groundwork for the imminent voluntary market, but several conflicts still need to be resolved

The commodification of carbon is well and truly underway. The Indian government’s intention of establishing an Indian Carbon Market (ICM) began taking some form last week with the notification of a draft framework for carbon trading. The Carbon Credit Trading Scheme (CCTS), 2023 sets out the basic governance structure and responsibilities of various stakeholders of the planned carbon market. The notification came within weeks of being hinted at by the country’s power minister RK Singh.

The move equips India to expand its coverage of industrial sectors eligible for mandatory emission cuts based on market-based carbon credits, pushing it further on the road to “reducing” emissions through a ‘cap-and-trade’ system. The system is designed to set an external cost of burning carbon dioxide and other greenhouse gas (GHG) emissions, which exacerbate the climate impacts of extreme heat, droughts, cyclones and rise in sea levels.

Weighing the price of carbon

Mobilising adequate finance in recent years has increasingly depended on the establishment of a price of carbon, which can then be incorporated in supply and value chains. Broadly, this can be done through taxation or market-based approaches. The latest estimates put the share of emissions covered by carbon pricing systems at about 23%. There is, however, significant diversity in specific approaches and the resultant price ascribed to carbon. An expert report on carbon pricing commissioned by the World Bank in 2017 recommended a carbon price of at least $40 per tonne of carbon to discourage businesses from burning fossil fuels and using the revenue generated in financing adaptation needs of the poor.

The new notification issued by the power ministry signals the beginning of the process of pricing-in carbon into India’s supply chains. The CCTS, building on the recent amendment to the Energy Conservation Act, provides more clarity on how the rules for the carbon market shall be devised and enforced. As per the draft, the government shall constitute a new 19-22 member National Steering Committee for Indian Carbon Market that will be in charge of the governance annd direct oversight of the market. Inputs from the steering committee is proposed to be formalised through the Bureau of Energy Efficiency, which will serve as the administrator of the market. The bureau is set to play a vital role in the functioning of the market, and in the maintenance of the demand and supply of credits. As such, the burden of developing the rules for the carbon market, including industry-specific emission reduction targets, measurement approaches for baseline emissions and reductions, procedures for accreditation of carbon credit verifiers and the issuance of credits, will fall on the BEE.

Incidentally, contrary to expectations that the country will first embark on creating a preliminary voluntary carbon market, the CCTS appears to set the stage for an imminent compliance market. Under a voluntary system, the demand for credits in the market is sustained through voluntary commitments and self-imposed targets of industries. This differs from a compliance market in which demand is sustained through legislative tools and codified industry-specific targets. These targets are yet to be set by the BEE, which will work in conjunction with the NSC. The CCTS, although focusing almost entirely on a compliance market, stops short of explicitly excluding voluntary participation in the market and leaves the door open.

“A voluntary market will be akin to an offsets market where developers can generate offsets that can then be sold to entities wishing to reduce their emissions voluntarily. The emissions trading scheme designed to deliver on industrial decarbonisation that is aligned with India’s NDC will have to be more in line with a ‘cap-and-trade’ regime rather than a voluntary one,” says Nishtha Singh, programme associate at the Council on Energy, Environment and Water (CEEW).

The stress on compliance in the CCTS is a likely reflection of the government’s keenness to make carbon credits traded through the scheme eligible for official accounting towards meeting India’s Nationally Determined Contributions and emission reduction strategy to meet its net-zero by 2070 pledge.

This “compliance market” with which such the ICM can be compared to is the Perform, Achieve and Trade (PAT) scheme designed by Bureau of Energy Efficiency (BEE). 

Meet uncle PAT

PAT was designed to accelerate implementation of cost-effective measures for energy efficiency in large industries. The scheme builds on the large variation in energy intensities of different units in the various notified sectors, ranging from among the best in the world to some of the most inefficient units. The energy intensity reduction target, mandated for each unit, depends on its current efficiency; with more efficient units having a lower reduction target and vice-versa.

Consider the list of stakeholders who form the ecosystem of the PAT scheme. First the BEE which is the nodal agency that identifies energy intensive industries as designated consumers (DC in official lingo), prescribes energy consumption norms for them and the modalities governing their compliance. Compliance among DCs is verified and evaluated by accredited energy auditors empanelled by the State Electricity Regulatory Commissions (SERCs). The whole machinery is intermediated by state-designated agencies, which include representation from renewable energy development agencies, electrical inspectorates, distribution companies and power departments. 

DCs that overachieve their targets are issued energy savings certificates (ESCerts) and non-achievers have to buy the ESCerts to maintain their compliance in three-year cycles. Announcements for six cycles have been made so far, starting in 2012.

ESCerts, which serve as the units of trade in the PAT regime, are issued by the Ministry of Power through nodal agency BEE to represent 1 metric tonne of emission reductions through energy saving interventions. While the SERC validates and regulates the supply of ESCerts, demand is maintained by DCs who fail to meet energy efficiency norms in their production processes. The Central Electricity Regulatory Commission (CERC) serves as the regulator for development of the ESCert market and is in charge of defining the framework for trading of the certificates done on power trading platform IEX (Indian Energy Exchange). ESCerts can be banked for a maximum of one compliance cycle, after which it expires.

While the PAT experience has been touted as a success in delivering rapid improvements in India’s industrial energy use, actual emission reductions delivered appear to be inconsistent. A study established that coal-based thermal power plants under the PAT scheme had reduced only 1-2% of their overall CO2 emissions. Additionally, the number of DCs and industries covered by the PAT saw a steep fall following the second cycle, which was assessed in 2018-19. From a high of 621 industries from 11 sectors in the second cycle, currently ongoing cycles (PAT-4 and PAT-5) cover just 110 and 135 industries, respectively. The report concluded that non-transparency, loose targets and overlooked deadlines were the reasons for the poor results of the PAT scheme. Another analysis of the PAT scheme also concluded that targets under the scheme are too loose for the creation of a robust market and not conducive to long-term investments in energy efficiency.

Rules of engagement 

The recent amendment to the Energy Conservation Act lays the groundwork for the imminent voluntary market. Legislation now allows notification of energy consumption standards for more entities, including vehicles, vessels, industrial units, buildings and establishments. The scope of buildings has also been expanded to include offices and residential buildings, with a minimum connected load of 100 kW or contract demand of 120 kVA. The Act also paves the way for the establishment of a credit-granting authority any agency authorised by the government will be able to issue ESCerts. The governance council of the BEE has been expanded to include more secretaries and representation from industry. 

Sale of carbon credits abroad will be prohibited until India meets its interim (2030) climate targets. If framework for other debt-instruments such as the Sovereign Green Bonds are anything to go by, carbon credits could be issued for projects including, but not limited to, carbon capture and storage (CCUS) technologies, renewable energy with storage (only stored component), solar thermal power, off-shore wind, green hydrogen, compressed biogas and alternate materials such as green ammonia.

The ICM will be based on emissions (reduced) as the unit of trade (rather than emission reductions specifically through energy saving methods as is the case with the PAT scheme). Experiences of emission trading from elsewhere in the world suggest the risks of an autonomous ecosystem, including an ever-widening web of intermediaries and stakeholders involved in complex, and often opaque, transactions. 

The first stakeholder in the system is the owner of the land where the offset project is implemented. Next in the chain comes the developer (who could be the same as the owner), who implements the project. Then come verifiers who certify, audit and validate to maintain the quality and accuracy of the generated credits. These are typically third-party accredited verifiers such as TÜV Nord Cert GmbH (Germany) and KBS Certification Services Pvt Ltd (India). The conditions for this accreditation and the process of the audits will be formulated by the BEE. Close in tow, come carbon credit registries which keep record of issued credits and their transactions through their lifecycle. The CCTS fixes the Grid Controller of India Limited as the registry for the Indian carbon market. This differs from structures established in other jurisdictions where private registries such as Verra Registry, the Gold Standard Registry, or the Markit Environmental Registry perform this function against a fee, and can also issue credits to the eligible and verified projects. The credits accrued can be traded on the spot market.

Working in conjunction, the NSC and the BEE form the state-funded regulatory structure that runs in parallel to set standards and ensure credibility of the market. The CCTS establishes the power exchanges as the platforms for trading the credits, under the regulatory oversight of the Central Electricity Regulatory Commission (CERC).

Navigating a minefield

Despite the draft CCTS notification, ICM’s credibility and effectiveness in reducing industrial emissions will depend on nature of the targets, how baselines are calculated and how emission reductions are generated. At this point, where the rubber meets the road, the draft notification remains silent — choosing instead to defer to the NSC and the BEE. “The BEE’s public position so far (indicates) that it may abide by the approach decided in the Article 6.4 of the Paris Agreement at the UNFCCC,” says Singh. This, however, poses a question on the timeline of the establishment of India’s market since Article 6.4 is only due to be finalised and implemented in 2026. “Whether an alternate methodology is borrowed from a reputed credit registry or auditor temporarily until Article 6.4 is finalised is to be seen,” she adds.

The most well known reason why carbon projects fail is that they are not additional, meaning that the project does not contribute to achieving additional climate benefits—compared to if the project had not existed. For example, a UN website has warned of developers who might claim that a forest owner would flatten 100% of the trees in a given area in five or 10 years if there was no offset project proposed. But if such a forest has been in the possession of the landowner for decades without the threat of being deforested, this logging is unlikely to happen. So the project is not creating additional climate benefits.

Rules for generating offsets will have to account for aspects of justice and equity in projects undertaken for a sustainable system. Take the case of the partnership between a local community of Papua New Guinea and American company New Ireland Hardwood Timber (NIHT). NIHT sold millions of dollars worth of carbon credits under the premise of afforestation to high profile clients in Australia while undercutting local communities. To top it off, rampant deforestation has also been reported from NIHT’s reported projects.

Another vital aspect will be how new and nascent technologies will be represented. While a vital aspect of the clean energy economy, several technologies still come with significant doubts around efficacy. A clear example of this is the area of CCUS.  According to IEEFA, globally, 80-90% of CCUS projects have been used to enhance oil recovery, while a minuscule 10-20% actually store CO2 underground without recovering oil. In the light of this evidence, the carbon neutral tag is misleading because CCUS does not capture Scope 3 emissions, which are created when the product is actually used or burnt. The tag is self-proclaimed by using carbon capture to capture the 10–15% of Scope 1 and Scope 2 emissions (the emissions generated from producing natural gas) during the gas production process or by purchasing carbon offsets. The biggest chunk of emissions is, therefore, not being accounted for in “carbon-neutral” claims. 

Avoiding such greenwashing has thus far been investors’ responsibility. Soon after the Union government passed the Energy Conservation Act, the Securities and Board Exchange of India (SEBI) released a list of ‘Dos and Don’ts’ relating to green debt securities to avoid greenwashing. SEBI’s caution on greenwashing cannot be overestimated when combined with a layer of uncertainties. Investor interests are exposing big industry players with fossil fuels investments engaged not only in politics of delay but also downplaying the climate crisis, and pushing the blame on individual customers. 

Regardless of how well the BEE and other regulatory bodies are able to navigate the minefield of potential issues in establishing a well-functioning carbon market, the root  question of whether markets are an appropriate route to deliver emission reductions still remains. “For effective emission reductions, the carbon price will have to be high and stable. This in itself is contrary to how an open market can function,” remarks CPI India director Dhruba Purkayastha.

Until this paradox is somehow resolved, the carbon market will remain volatile and speculative to some extent, and thus ineffective. This speculative aspect was highlighted in a Greenpeace investigation, which found around 250 projects where brokers resold credits for thrice its purchase price. The resultant price was ultimately several times the value of actual climate benefits delivered. Experts say if you take a cut you have an incentive to sell as many credits as you can. The market model allows brokers to encourage clients to offset emissions rather than reduce them.

Pressure on one side, conflicts on the other

The amendment to the Energy Conservation Act through India’s legislative houses was passed, but not without debate. Issues raised in Parliament were primarily around conflicts of domain and of interest. It was said that the subject of carbon credits was new to the House and required larger inputs. Therefore, the bill should have come under standing committee and legislative scrutiny, but it didn’t.

MPs pointed out that the power ministry, which also directly works with industry, is setting up compliance standards, funding and mitigation mechanisms, which require environmental protection—a job of the Ministry of Environment, Forest and Climate Change (MOEFCC). Interestingly, days before the notification of CCTS, the MOEFCC notified the draft of separate set of rules for a voluntary market of green credits. While it appears this regime would run completely independent of the CCTS and under a separate governance structure, the details on the basis of issue of green credits and how demand would be generated remain sparse.

Secondly, the norms have been set without adequate representation of states (only five state representatives are allowed), while the law draws on the resources of all states, without factoring in their unique biodiversities as well as climatic change impacts. The CPIM said given the limited number of seats, they would not be able to register their opinion at the BEE, which is a right every state has. Recent reporting suggests that intervention from the PMO directly resulted in the rejection of more active involvement of freshly nominated and established state agencies in the functioning of the market.

Beyond the pressing needs of mobilising climate finance, the urgency of a carbon market is coming from overseas. With the EU initiating its cross-border carbon tax (and others looking set to follow), developing countries seeking to protect its export-oriented industries are searching for ways to protect their interest. In India, establishing a voluntary market can arguably be seen as a part of this effort, with Indian officials appealing for recognition of carbon credit certificates generated and traded in India.

How India threads the needle, with all the added implications of a ticking clock, will determine the role and significance of any emission trading scheme that it develops.