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What is a Carbon Market?

The Union Government has introduced the Energy Conservation (Amendment) Bill 2022 in the Parliament. The purpose in the Bill is to improve existing legislation, the Energy Conservation Act, 2001. The Amendments are expected to facilitate the attainment of more ambitious climate change goals and to facilitate that we can move faster towards an economy that is low carbon. It was the Energy Conservation Act, 2001 was the catalyst for the initial phase of India’s shift to an energy efficient future. Through the years it has been observed that the intensity of energy (energy consumed per unit of GDP) of India’s economy has declined consistently. However, as India is preparing to take on more ambitious climate change action, as promised by the Paris Agreement, there is an urgent need to expand the scope of Act to include instruments that can aid in the accomplishment of these ambitious targets. One of the amendments proposed is to create a national carbon market to ease trading in carbon credits.

What is the scope of the proposed amendments proposed under the Energy Conservation (Amendment) Bill 2022?

The Bill has two main goals: (a) It seeks to make it compulsory for certain groups of industrial, commercial and even residential customers to switch to green energy sources. A prescribed minimum proportion of their energy consumption is to come from renewable or non-fossil fuel sources; (b) It is aimed at helping establish a domestic carbon market and facilitate the trade carbon credits. It aims to expand the range of energy conservation to include the construction of large residential buildings. At present, guidelines for energy conservation have been applied mostly on industrial and commercial complexes.

What is a Carbon Market?

Carbon Markets and Carbon Credits are the components of emission trading, a method of trading that aims to to reduce the concentration of Greenhouse gases (GHG) in the atmosphere. It provides financial incentives to cut down on the emissions of the pollutant that is designated. A carbon market allows investors and corporations to trade both carbon offsets and carbon credits simultaneously.

Carbon credits (or allowances) function as permits for emissions. If a business purchases a carbon credit, they gain permission to produce more CO2 emissions. A carbon credit that is tradable equals one ton of carbon dioxide, or the equivalent amount of a greenhouse gas that is reduced, sequestered or avoided.

Credits are measured against ‘benchmarks which are allowed GHG emissions. If emissions fall below the permitted limit, the emitter is awarded carbon credits (reducing 1 tonne of CO2 earns 1 carbon credit). If emissions exceed the limit allowed, the emitter has to purchase carbon credits from those who possess excess credits. Thus, crossing the emissions limit results in an expense (amount spent on purchase of carbon credits) on the emitter. The idea is that this cost will force emitters to be more efficient and decrease emission.

There are two kinds market for carbon: (a) One is a regulated market, set by “cap-and-trade” laws at the state and regional levels. (b) The second type is a voluntary market in which consumers and businesses buy credits (of their own volition) to reduce their carbon emissions.

Carbon Markets were allowed as part of the UN Kyoto Protocol. Its Clean Development Mechanism (CDM) allowed industrialized nations to reduce emissions abroad where that might be cheaper than domestically through planting trees in tropical regions.

How can companies reduce carbon emissions?

There are multiple ways that companies can reduce carbon emission. They are broadly classified into (a) Carbon Avoidance/Reduction Projects (i.e., reduce the amount of carbon emitted); (b) Carbon Removal/Sequestration Project (i.e., remove the carbon already emitted from the atmosphere).

Investment in renewable energy via funding wind, hydro, solar, and geothermal power generation projects or switching to these power sources wherever feasible.

Improving energy efficiency across the world, for instance by providing more efficient cook stoves to those living in impoverished or rural regions.

Capturing carbon from the atmosphere to make biofuel is a carbon-neutral energy source.

Releasing biomass back into the soil as mulch following harvest instead of removing or burning. This technique reduces the loss of water from the soil surface, which assists in conserving the water. It also aids in feeding earthworms and soil microbes. permitting nutrients to cycle through and build soil structure.

Promoting forest regrowth through tree-planting and reforestation initiatives.

Alternating to other fuel types using biofuels with lower carbon levels such as corn and biomass-derived ethanol and biodiesel.

What’s the state in Carbon Markets across the world?

National or Regional

Carbon markets in the region or at home are in operation in various places, most notably in Europe in which the Emission Trading Scheme (ETS) is based with similar principles. Industries within Europe have set emission standards that they have to comply with as well as buy and sell credits on the basis of their performance. China, too, has a carbon market in its domestic market.

A similar incentive scheme to encourage efficiency in energy has been operating in India for over a decade. The BEE scheme, known as PAT (or achieve, perform and trade) permits units to be awarded efficiency certificates if they exceed the required efficiency standards. The laggards can buy these certificates to allow them to operate.

International

Under the Kyoto Protocol, carbon markets have worked at the international scale as well. In the Kyoto Protocol had prescribed emission reduction targets for a certain group consisting of developed nations (Annex I, Developed Countries). Other countries did not have any such targets, but if they did reduce their emissions, they would be able to earn credits for carbon. These carbon credits could later be sold to advanced countries who had difficulty meeting their reduction goals. The system was successful for a few years. However, the market crashed due to the absence of demands in carbon credits.

The world was in the process of negotiating a new climate treaty that would replace Kyoto Protocol, Kyoto Protocol, the developed countries were no longer feeling the necessity to adhere to their targets set under the Kyoto Protocol. Similar carbon markets are planned to be implemented under an agreement that will succeed the Paris Agreement, but its specifics are still being worked out.

What are the advantages of a Carbon Market?

In the beginning, it can assist in mitigating the adverse impacts of climate change through reducing the GHG emissions.

Second, there are multiple benefits of offset projects, including the management of ecosystems, preservation of forests sustainable agriculture, renewable energy generation in third-world countries, etc.

Third, the voluntary marketplace for carbon offsets in the form of offsets is smaller in comparison to the conformity market, but expected to grow much more in the near future. It’s open to individuals or companies as well as other companies who wish to reduce or eliminate their carbon footprint, however, they aren’t obliged to comply with the law.

Fourth, the public is becoming aware of the importance of carbon emissions. In turn, they’re becoming more critical of companies that don’t take Climate change very seriously. By donating to carbon offset projects, businesses signal to consumers and investors that they’re not paying simply lip service in order to tackle climate change.

Fifth, it will open another revenue stream for environmentally-friendly businesses. For instance, Tesla, the electric automobile maker, sold carbon credits to legacy automobile makers to the tune of $518 million just in the first quarter of 2021.

What are the biggest challenges facing working of Carbon Markets?

First, there are questions regarding the effectiveness of carbon markets in reducing emissions. Some companies simply buy credits without making any effort to cut emissions by themselves. It’s less expensive for them to purchase carbon credits rather instead of investing in emission reducing technologies e.g. An analysis by the Center for Science and Environment of the PAT scheme for thermal power plants revealed that the value of an ESCert* is very smaller — INR 700 — in comparison to the cost of INR 4,020 that must be made for reducing energy equivalent to one tonne. Unless, the price in carbon credits greater than the cost of reducing emissions, there is no incentive for high emitters to take steps to cut their carbon emissions (i.e. businesses have to invest more in buying credits rather than investing in emission reduction technology).

*(ESCerts are similar to carbon certificates which can be sold and purchased in the carbon market scheme).

Environmentalists argue that only high-quality carbon offsets have the potential to reduce emissions. High-quality carbon offsets possess certain features like (a) Additionality The reduction in emissions must be added i.e., they would not have occurred without an offset credit market e.g. Renewable project could have been set up just because a large emitter paid for it; (b) Verifiable: There need to be audits that are able for monitoring and reporting of emission reductions (c) Permanence This means that the reduction in emissions can be irreversible.

However, the majority of credits in markets are of poor quality i.e. they do not fulfill the above requirements. A majority of these credits aren’t ‘additional’ i.e. they are not part of the emission reduction projects would have occurred in the absence of carbon credits (without any chance that project managers could market carbon offset credits). It is also very difficult to determine what constitutes ‘additionality’. According to an American-based environmental group more than 60% percent of the credit available are from projects that have ‘questionable additionality claims’.

In some cases there are instances where the reduction in emissions is not always permanent. There are instances when afforestation projects were undertaken to purchase carbon credits. However, later on the trees planted were removed in order to reverse the reduction.

Thirdly, buying carbon credits can deviate the rich nations from the path of reducing their emissions. They could simply keep emitting and buy low-cost carbon credits in the developing countries.

Fourth, there is a massive surplus of carbon credits on the market for voluntary carbon credits. According to an estimate of credits for roughly a billion tons of CO2 are available for sale on the market for voluntary carbon credits. However, there were more buyers than sellers. The excess of supply can lower carbon credits’ price and makes it more easy for emitters to offset while continuing high emissions.

Fifth, It is difficult to establish the amount of carbon that offset projects reduce (like wind energy or afforestation project). The problem is determining baseline emissions (Emissions baseline represents what would happen if the project didn’t happen i.e. the emissions in the absence of projects). This is why it’s difficult to determine the extent of emission reductions and assigning carbon credits.

India’s own PAT (Perform Achieve, Trade, Perform) Scheme has failed to achieve meaningful emissions reduction. According to an analysis done by the Center for Science and Environment the reduction in emissions achieved as a result of the scheme was only 1.57% and 1.44 percent in the two cycles.

What can be done to prepare ahead?

First, there is a need for a creation of a national level environment regulator on the model of SEBi (Stock Market Regulator), RBI (Banking Regulator) to ensure carbon markets work efficiently.

Second, there must be strong regulatory safeguards to ensure that emission offsets that are traded are of high quality. Otherwise, as experts say an unreliable carbon market can cause more harm than good.

Third, there is a need to create a sense of environmental awareness for the public at large to ensure that they aware of their environmental responsibilities. For instance, consumers could purchase offsets for emissions from particular high-emissions activities like a lengthy flight, or buy offsets on a regular basis to minimize their carbon footprint.

Fourth, it is crucial that cap-and-trade does not become an inspect-and-extort regime in India. In this regard, a technology-enabled model of open verification could be used by the government.

Conclusion

The development of a national carbon market is a progressive step. But, the real benefit is contingent upon the effectiveness in the operation of the market. For this, the Government must ensure that the right regulations are in place. Additionally, there should be a periodic reviews of the operation and the corrective measures it is required. Climate change is real and imminent. The government must take all steps to ease the burden.