Trading for a greener tomorrow

The way forward to meet the nationally determined contributions is a well-regulated domestic emission trading mechanism

The Government of India has taken a welcome step by notifying the Carbon Credit Trading Scheme (CCTS) in June under the Energy Conservation Act, 2001.

The scheme entails driving the market by setting greenhouse gas (GHG) emission intensity reduction targets for entities in selected sectors. The entities that exceed the set targets will be issued carbon credit certificates, while those failing to achieve the targets can meet the shortfall by purchasing these certificates from the market. Each carbon credit certificate will be equivalent to one tonne of CO2e (carbon dioxide equivalent). The scheme aims to develop a well-functioning regulated domestic carbon credit trading market, with transparent price discovery. This aligns with India’s goal of achieving its updated nationally determined contributions (NDCs) commitment by 2030, and becoming net-zero by 2070.

The agencies/authorities involved in planning, administrating and regulating the scheme include the Ministry of Power (MoP), and the Ministry of Environment, Forests and Climate Change (MoEF&CC) for oversight; the Bureau of Energy Efficiency (Bee) for administering the scheme and formulating the targets for the obligated entities under the scheme; the Grid Controller of India for registering the obligated entities and maintaining the record of transactions amongst them; and the Central Electricity Regulatory Commission (Cerc) for regulating the trading of carbon credit certificates.

The Kyoto protocol, with an overall commitment period from 2008 to 2020, mandated only the Annex-1 countries (developed countries) to reduce their emissions according to quantified targets. The other participating countries agreed to reduce emissions but with no targets.

The position changed in the 21st Conference of Parties (CoP) meeting at Paris in 2015, which came out with the Paris agreement to replace the Kyoto protocol effective from 2020. The Paris agreement, while acknowledging the principle of common but differentiated responsibilities based on respective capabilities, moves away from legally binding targets only for developed countries. Instead, it relies on a consensual mechanism in which all countries, developed and developing, are expected to declare intended NDCs every five years beginning 2020 (countries could revise their commitments but only upwards). The effectiveness of the Paris agreement is based on the premise of “naming and shaming” principle.

The Kyoto protocol defined international emissions trading, which Annex-1 countries could use to meet their targets. While emissions trading did pick up after the ratification of the Kyoto protocol (2005) in the EU and some other developed jurisdictions, it was virtually a non-starter in the developing world. However, many projects in these countries (including India) have been participating in the voluntary global carbon credit market. 

Now, in the changed scenario after the Paris agreement, when each country has virtually been left to fend for itself, the option of establishing a well-regulated domestic emission trading mechanism with proper guardrail, to meet the NDC commitments needs to be seriously considered by all jurisdictions.

The CCTS should be seen in this backdrop. Carbon credit trading is a market-based mechanism rooted in the sound economic concept of differential marginal costs faced by different entities in reducing the carbon intensity of their productions. The framework is likely to facilitate investments in emissions reduction technologies, projects, and processes towards accelerated de-carbonisation of the Indian economy.

The CCTS gives a pivotal oversight and regulatory role to the MoP. This is perhaps justified on two counts. One, the energy sector in India, like anywhere in the world, contributes to a major chunk of the total GHG emissions. Two, the Bee has the experience of administering the “perform achieve and trade” (Pat) scheme, which involves the issuance and trading of energy saving certificates (ESCs). Then, the Cerc has been regulating the trading of ESCs and renewable energy certificates (RECs). The learnings from running these schemes would be helpful in implementing CCTS.

The Pat scheme has been in operation for over a decade. The demand-supply mismatch has proven to be one of the stumbling blocks. It has been a buyers’ market. Over-supply of ESCs, miss-priced allocations of certificates, restricting participation to only designated consumers, and limited trading period have been the problem areas.

As for the RECs’ market, the demand comes from the entities obligated to purchase a certain proportion of electricity from renewable sources in accordance with their RPO targets — for example, discoms, open access consumers, and captive power producers. The demand for RECs has remained muted for various reasons, including on account of poor enforcement of RPO obligations.

The CCTS notification states that the obligated entities will also be required to meet any other targets, such as the use of non-fossil-based energy or reduction of specific energy consumption as may be notified by the MoP. This would lead to fragmentation in the carbon market, which is not desirable. Instead, the markets for ESCs and RECs should be subsumed in and made fungible with the carbon credit market. The participants in these markets should move to CCTS. The measurement unit should be uniform, and in terms of tonnes of CO2e.

The CCTS notification is an overarching framework. Much detailing needs to be done for the scheme to take off. For instance, questions remain about which sectors are to be covered (obligated entities) under the scheme, and the criteria for selecting such sectors (entities); the methodology for dis-aggregating the overall national level NDC GHG emission targets at the sectoral and entity level; the envisaged mechanism for monitoring, reporting and verifying GHG emissions; and the criteria for issuing carbon credit certificates, including their validity period.

Some suggestions may be in order. Unlike the trading markets for ESCs and RECs, the category of eligible participants should be increased for CCTS, including financial institutions, banks, and traders, to provide liquidity and help in better price discovery. Going forward, futures trading in carbon credits may be allowed on commodity derivatives trading exchanges regulated by the market regulator.

Gradually, the scheme may extend its scope to covering GHG emissions from sources/activities beyond the energy and industry sector to include agriculture, forestry and land use, transportation, airlines, waste management, and carbon capture and storage. Foreign entities’ participation, leading to carbon credits export, shouldn’t be allowed until we are reasonably confident of meeting our own NDC commitments. In fact, till then, the projects located in India should not be allowed to participate in the voluntary global carbon credit market. The CCTS should be operationalised at the earliest.

The writer is a distinguished fellow at ORF, and former chairman of Sebi