Carbon trading is not a recent concept, as it was initially introduced under the Kyoto Protocol 1997.
The world is facing a critical threat with climate shifts. It is a monumental issue that endangers everyone, irrespective of their economic status or where they live, whether in a developed or developing nation. This threat is immediate and clear to us all. The urgent requirement is to lower greenhouse gas emissions, including carbon dioxide (CO2) and methane (CH4). However, achieving emission reductions is costly, typically requiring substantial projects.
Governments are employing carbon trading as a strategy to decrease their emissions. Market-based strategies for carbon mitigation have rapidly expanded since the 2015 Paris Agreement, with 73 national/sub-national jurisdictions encompassing 11.66 billion tonnes of CO2e emissions, equating to about 23 percent of worldwide greenhouse gas emissions. These solutions encompass carbon pricing and cap-and-trade systems, with prominent examples in the EU, UK, Sweden, and China. This market-driven approach is designed to create economic incentives for nations and companies to lessen their impact on the environment.
From travelling and farming to simply watching a video, nearly every action leases gases like CO2, contributing to the greenhouse effect and climate change. In the Indian context, our primary energy source is coal, which, when burned to generate power, releases significant amounts of CO2. The sole viable approach to curbing emissions in this context is to capture the CO2 emissions from thermal power plants and store them underground. These essential products, like carbon capture and sequestration, are crucial for moving toward a decarbonised economy and lifestyle. However, they come at a high cost. Shifting toward an economy with reduced carbon emissions requires a substantial financial investment. One pertinent question is who will shoulder this financial burden. One possible solution lies in carbon markets. These markets could play a role in addressing this issue by facilitating financial arrangements for emission reduction efforts.
Carbon Trading: A Market-Driven Solution
On June 28, 2023, the Ministry of Power, Government of India, officially introduced the Carbon Credit Trading Scheme 2023, also known as carbon offsets. But what exactly are carbon credits, and what is the carbon market? Carbon credits, or carbon offsets, are units of measurement that represent the reduction or removal of greenhouse gas emissions, such as CO2, below a specific benchmark. You earn carbon credits when you engage in activities that decrease these emissions or actively remove greenhouse gases from the atmosphere. Each carbon credit is equivalent to one metric ton of CO2 or equivalent emissions that have been reduced or eliminated. Like company shares, these carbon credits can be traded in a market. Entities typically purchase them with a legal obligation to reduce their greenhouse gas emissions but cannot do so through other means. Organisations that voluntarily commit to emission reduction can also buy these credits. This interplay between the instrument known as carbon credit and sellers and buyers creates a carbon market.
Carbon trading is not a recent concept, as it was initially introduced under the Kyoto Protocol 1997. It involved granting certified emission reduction certificates (CERs) to those who successfully reduced emissions or removed greenhouse gases, like CO2, from the atmosphere. These CERs could be traded in the market, and this system continued for several years. However, the prices of CERs eventually plummeted, leaving many Indian companies with substantial quantities of worthless CERs.
Today, there are numerous carbon markets worldwide, which broadly fall into two categories: the voluntary market and the compliance market. In the voluntary market, buyers are not legally bound to reduce emissions but do so voluntarily to improve the environment, even if it involves a cost. Prominent global companies like Google, Microsoft, Apple, and Shell participate in the voluntary market. In 2020, the voluntary carbon market was estimated to be worth $2 billion, but experts suggest it could grow to $50 billion by 2030, depending on the market price of carbon credits.
On the other hand, the compliance market involves buyers who are legally obligated to reduce emissions. This market typically operates through a cap and trade mechanism. This mechanism sets emission baselines or allows a specific level of emissions. Entities bound by law must limit their emissions to the level set by the authority. If their emissions fall below this level, they receive carbon credits. However, if their emissions exceed the designated level, they can purchase carbon credits from entities that have successfully reduced their emissions. This cap-and-trade market is sometimes referred to as the allowance market, with the carbon credits in this market known as allowances.
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The Birth of India's Carbon Credit Trading Scheme
India lacks a formal carbon pricing system but applies implicit carbon taxes to coal and petroleum products. Introducing carbon pricing is perceived as a less disruptive approach to generating revenue, albeit one that necessitates careful consideration, including dealing with potential political complexities. India may need to adopt carbon pricing due to mounting global pressure and the potential impact of carbon-related trade barriers.
Now, let's examine the notifications issued by the government of India in June 2023. It is a significant step towards establishing an Indian carbon market, where carbon credits are generated, sold, and purchased within India. This market will operate through the cap and trade mechanism. The Ministry of Power will identify the sectors and obligated entities, set emission intensity targets, and then pass this information to the Ministry of Environment, Forests, and Climate Change for notification.
The Ministry of Power will base its decisions on the Bureau of Energy Efficiency (BEE) recommendations. The BEE will be the administrator and the authority responsible for issuing carbon credits. The Central Electricity Regulatory Commission (CERC) will regulate the trading of carbon credits, while the POSOCO will maintain a central register of obligated entities and record all trading transactions. A National Steering Committee, composed of officials from the Ministries of Power and Environment, along with expert members, CEA, CERC, and other relevant entities, will assist the BEE in implementing the scheme. While this is a significant step towards an Indian carbon market, many details and processes, such as naming sectors, entities, emission targets, and verification procedures, still need to be worked out. Also read: It's always a good time to talk about climate change
Challenges in Establishing a Vibrant Carbon Market
The commendable efforts of the Indian government to establish a carbon market come with a host of formidable challenges. First and foremost, the task of generating demand is a primary concern. In any market, the delicate balance between supply and demand is crucial. Given the government's intention to impose emission reduction obligations on various sectors, such as cement, steel, and electricity, the supply of carbon credits is expected to be substantial. However, the critical question remains: who will be the purchasers of these carbon credits? Without a harmonious alignment between supply and demand, there is a looming risk of plummeting carbon credit prices, potentially discouraging companies from pursuing emission reduction activities.
The second major challenge involves the establishment of emission limits, commonly known as baselines. Setting these baselines can become highly contentious, as companies with varying technologies and raw materials may object to uniform emission limits. The government's experience with the PAT (Perform, Achieve, and Trade) scheme, primarily focusing on energy efficiency, offers insights into the dynamics and challenges of cap and trade mechanisms. Nevertheless, it's essential to recognise that the carbon credit market is significantly larger and more complex.
Another challenge in this endeavour is the potential inclusion of a secondary market for carbon credits, which might lead to speculation by investors. While such a secondary market can add depth to the overall carbon market, it necessitates careful regulation to prevent adverse consequences. Additionally, incorporating derivatives in carbon credits, such as futures and options, presents another complex issue that requires meticulous consideration.
Lastly, ensuring a robust regulatory framework for carbon markets is a substantial challenge. Determining which regulatory authority will oversee the market, coordinate cap and trade mechanisms, and enforce compliance is pivotal to the success of the carbon credit trading scheme. These challenges collectively underscore the intricate nature of establishing a thriving carbon market in India.
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Policy Challenges in Tradable Emission Permits: Balancing Profit and Morality
As we navigate the three key policy challenges mentioned earlier, a more profound question emerges: Can tradable emission permits combat air pollution effectively? Is pollution merely a business cost, or should we hold excessive polluters morally accountable? To address these dilemmas, we must consider not only economic aspects but also the environmental values we aim to preserve.
This perspective is akin to allowing individuals to pay for littering, raising significant concerns. Instead of weakening the moral condemnation tied to environmental degradation, we must focus on strengthening it. Allowing affluent companies and nations to purchase their way out of substantial reductions in energy consumption could have far-reaching consequences. Such a practice undermines the principle of shared sacrifice, which is crucial for global cooperation on environmental issues.
When wealthy countries or companies can evade significant reductions in energy use by buying pollution rights or investing in emission reduction projects abroad, two vital principles are eroded: Viewing nature as a resource to be exploited and diminishing the spirit of shared sacrifice needed to establish a global environmental ethic. Combatting global warming goes beyond designing incentives and securing international commitments; it hinges on shifting environmental norms and attitudes. Cultivating a new environmental ethic that promotes restraint and shared sacrifice may be essential, even if it means implementing a global market for pollution rights. Thus, it is the moment to bring ethics, sociology, economics, and the environment onto the same page for a sustainable future.Anil Mehta is an alumnus of the Advanced Management Programme in Public Policy (AMPPP), Bharti Institute of Public Policy, Indian School of Business. An enthusiast in Energy Economics, Environment, and policy, he works as Principal-Yield and Service Delivery with Secure Meters Limited.
Anjal Prakash is a Clinical Associate Professor (Research) at Bharti Institute of Public Policy, Indian School of Business (ISB). He teaches sustainability at ISB and contributes to IPCC reports.
[This article has been reproduced with permission from the Indian School of Business, India]