Carbon Markets: An Opportunity for India and the Planet - Part I
Separating the signal from the noise in carbon markets, where India is one of the largest players and will take center stage.
6 in 60: The 1 Minute Digest
This week’s Indian Energy Quadfecta (IEQ) is the first of a two-part series on Carbon Markets - one of the most exciting and divisive parts of the global energy transition. Carbon markets - and especially the offsets which they comprise - have been called everything from “fundamental to achieving net-zero” to “a sham”, and everything in between. India, as one of the world’s largest sources of carbon credits, will take center stage in this dialogue. Here are 6 key takeaways in 60 seconds:
A Foundation: A little over 2 months ago, India made climate headlines by passing legislation to enable a national carbon market through an amendment to the Energy Conservation Act of 2001. The bill lays the foundation for a domestic market explicitly geared towards achieving its national climate goals.
Supplier to the World: India had already been a significant player in the voluntary carbon market: it is one of the largest suppliers of credits in the world, accounting for 17% of global supply between 2010-22.
A Crisis Too Precious to Be Wasted: Voluntary carbon markets have gone through somewhat of a crisis of credibility, with report after report after report raising doubts. But blanket claims of fraud are often too simplistic. India has an opportunity to emerge from this crisis as a leader, by proactively developing mechanisms for separating highest quality credits from the rest.
Credit nationalism: India experimented with the idea of a ban on exporting carbon credits to prioritize meeting its own climate nationally determined contributions (NDCs). Any export restrictions are likely to be temporary and not entirely prohibitive, but this does signal that carbon markets - no matter how international - will face stiff competition from domestic objectives.
Devil in the Details: India’s recent legislation looks to create a emissions trading market for carbon, following the lead of the EU, China, South Korea, and California. But key implementation steps remain: deciding on the emissions cap and its sectoral breakdown, transitioning existing credits to carbon credits, price stabilization mechanisms, and linkages between domestic and international markets.
Key to Success: Establish a clear framework for testing additionality, conservatism, and permanence that is germane to India and also to specific its hard-to-abate sectors. Market mechanisms should be constructed to reward buyers and sellers of the highest quality credits that are transparent and move the needle on emissions.
The Deeper Dive
Carbon Markets 101: A Quick Overview
Before going any further, let’s do a quick refresher of the basics. Carbon markets, which gained prominence after the Kyoto protocol in 1997, are set up to facilitate a market-based solution to reduce carbon emissions.
The General Concept: if entity A is able to reduce, remove, or avoid one ton of CO2 from the atmosphere, this action generates a ‘credit’. This credit can then be sold to a buyer, entity B, who purchases it as proof that they have paid for emissions reductions - either because they want to (voluntary carbon market) or because regulators forced them to through an emissions cap (involuntary or compliance carbon market)
Voluntary Carbon Markets (VCM): In the voluntary markets, buying carbon credits is a way for companies to indirectly fund projects that mitigate carbon emissions somewhere in the world, and thereby ‘offset’ their own carbon emissions. A lot of companies who have signed net-zero pledges hope to achieve their targets through these offsets.
Examples of offset projects include:
Carbon Removal and Sequestration: Direct air capture and other engineering solutions to remove and sequester carbon underground
Nature-based solutions: Afforestation projects such as mangrove plantations that take advantage of plants’ ability to absorb CO2
Involuntary / Compliance Carbon Markets: Unlike voluntary markets, compliance markets are created by regulation - not by companies’ independent commitments. Countries and their regulators typically utilize a ‘cap-and-trade’ system which consists of (i) an aggregate limit on GHG emissions, (ii) carbon allowances for companies, and (iii) ability for companies to buy/sell credits if they have a deficit / surplus of carbon emissions relative to their allowance.
Importantly, despite being part of international climate discussions for decades, carbon markets are still early in their evolution. Some still describe it as the wild, wild, west of the energy transition. Many of the details - and the source for many of the challenges we’ll dive in to - are yet to be figured out.
India: The Carbon Credit Machine
Over the past decade, India has been one of the largest sources of carbon credits (voluntary) in the world, accounting for 17% of global supply of credits between 2010-22 according to S&P Global.
As companies around the world jumped on the bandwagon of declaring net zero targets (the count is well over 4,000 entities globally now), they relied heavily on offsets. India led developing countries in feeding this demand and became a carbon credit supplier of serious volume to the world. This boom in carbon offsets put Indian project developers - those who generate credits - in a ‘sweet spot’.
Carbon Nationalism?
“Carbon credits are not going to be exported. No question…These credits will have to be generated by domestic companies, bought by domestic companies.”
Raj Kumar Singh - Minister of Power, New & Renewable Energy, India
Link to Source
After enjoying a meaningful period as the credit supplier to the world, India experimented with banning the export of carbon credits in August 2022, which made international headlines. The reason for the move was simple: prioritize meeting India’s own climate goals first, before assisting companies in other countries to do the same. The government has since partly reversed course and clarified that it will not be a full ban, and any restriction won’t be complete or necessarily permanent. Surplus credits - beyond those necessary for India to meet its own climate commitments - would be eligible for export.
India is not alone in restricting export of carbon credits - Papa New Guinea and Indonesia did the same last year. Regardless of how many ultimately end up being export-eligible, it is clear that carbon nationalism will be a key driver across the world.
Carbon Credit Quality: A Crisis of Credibility
Over the past 12-18 months, carbon offsets have faced somewhat of a crisis of credibility, with serious doubts cast over whether some offset projects actually make an emissions impact. Report after report after report have called offsets into question.
But there is a clear danger in universally proclaiming “fraud!”. There is nothing inherently fraudulent about carbon offsets. It is rather a question of measuring and enforcing rigorous standards to ensure their legitimacy.
But how does one separate the good quality, legitimate credits from the dubious ones? We start with asking four fundamental questions:
Is it “additional”? - The concept of ‘additionality’ requires that the carbon emissions reduced by an offset project truly would not have occured without it. For example, a wind power project that is already economical - and therefore would have been funded even without credits - may avoid emissions, but this avoidance is not ‘additional’
What’s the baseline? - Closely related to the concept of additionality is the baseline one measures against. Some of the more controversial carbon offset projects rely on ‘avoided deforestation’, where it is unclear how much deforestation would have occurred in the business-as-usual scenario. This makes it very difficult to measure how much carbon was actually avoided
Is it “permanent”? - The goal is to remove carbon emissions from the atmosphere permanently, not just at the time of issuing the carbon credit.
Is there “leakage”? - Leakage occurs, for example, if a carbon offset project protected a forest from logging but leads to an increase in logging somewhere else
Even for legitimate offsets, there is a difference in perceived quality. One such measure is whether a carbon credit avoids emissions or actually reduces emissions - the latter invites fewer questions than the former. According to this report by Shell and BCG, 80% of the carbon credits issued in 2021 were avoidance credits rather than removal credits.
The Case of EKI
A well-documented rider of the carbon credit roller coaster was the Indian company, EKI Energy Services, whose shares gained 10,000% in the Bombay Stock Exchange after its IPO in 2021. This was followed by a severe contraction in its market value after doubts arose around the quality of the underlying credits. The vast majority of offsets that EKI sold are tied to renewable energy, which run into ‘additionality’ concerns described earlier. Amidst these challenges, the company is looking to upgrade its offset quality to arrest a decline in market value.
Formal Legislative Support: A Welcome Addition
With India’s renewed commitment to cut the carbon intensity of its economy to 45% of its 2005 level by 2030, the country’s legislature has shined a spotlight on carbon markets. In December 2022, India initiated its domestic carbon market and empowered the central government to specify a carbon credit trading scheme via an amendment to the the Energy Conservation Act of 2001.
In all fairness, this bill is more of a framework for a policy, rather than an actual policy at this stage. But it does represent a significant step. While this legislative framework will be the first direct move towards a domestic carbon market, India did have several pre-existing market mechanisms related to emissions trading:
Renewable Energy Certificates (RECs): An existing mechanism launched in 2010 to enable Indian states to fulfill their renewable power obligations through inter-state trades
Perform, Achieve, and Trade (PAT) Scheme: Launched by the Bureau of Energy Efficiency in 2012 to enhance industrial energy efficiency in India by specifying targets and allowing certificate trades
Gujarat Cap-and-Trade Market: India’s first carbon trading market was announced in May 2022 through the Gujarat cap-and-trade scheme. This is intended to build on the earlier emissions trading market focused on particulate matter.
With this first step taken, some key implementation challenges in the domestic carbon market include (i) deciding on the aggregate emissions cap and its sectoral breakdown, (ii) a transition plan for existing RECs and ESCerts, (iii) the price stabilization mechanism in the event of high carbon price fluctuations, and (iv) linkages between domestic market and international market for carbon, among others (see this report by CEEW for additional detail).
The market is expected to begin operations by mid-2023, with existing REC and Energy Savings Certificates (ESCerts) transforming into tradeable carbon credits by 2026.
A Crisis Too Precious to be Wasted
The carbon offset market has certainly taken a reputational hit recently. And amidst this crisis is an opportunity for India to establish itself as a world leader for clean, transparent, and impactful carbon credits. If it effectively leverages its track record as a credit supplier, its recently initiated domestic market, and regulatory institutions that can enforce quality, India can be as well positioned as any.
A well oiled carbon market in India can also be a boon for its domestic economy. Given the disproportionate role that agriculture plays in the Indian economy - farming sustains half of India’s population and represents 70% of rural jobs - the sector stands as a natural place to develop carbon markets. As outlined in this World Economic Forum brief, soil carbon sequestration and regenerative agriculture can be key carbon sinks for the world, and therefore also a monetization pathway for the millions of small-scale farmers and the broader agriculture industry.
Next Up: India and the International Carbon Trade
There is a clear fault line in international carbon markets: developed countries represent most of the demand for carbon credits, and developing countries supply them. This places countries like India - with ample supply but also growing domestic demand for offsets - in a particularly influential position. Tune in to the next edition of IEQ to read more about the exciting world of the international carbon trade!
REFERENCES
In addition to the direct links provided in the write-up, I’d recommend reading the following references which I enjoyed reading:
The CEWW Council, “Understanding Carbon Markets: Prospects for India and Stakeholder Perspectives”, February 2023, https://www.ceew.in/sites/default/files/carbon-credit-markets-in-india-prospects-stakeholder-perspectives.pdf
PRS India, Bill Track, “The Energy Conservation (Amendment) Bill, 2022”, https://prsindia.org/billtrack/the-energy-conservation-amendment-bill-2022
Shell and BCG, “The Voluntary Carbon Market: 2022 Insights and Trends”, https://www.shell.com/shellenergy/othersolutions/carbonmarketreports/_jcr_content/root/main/section/simple_1854223447/simple/call_to_action/links/item0.stream/1674112112488/ea9cd7629a713c0efa53be567b2d81bcbcd704a7/the-voluntary-carbon-market-2022-insights-and-trends.pdf
Mckinsey, Putting Carbon Markets to Work on the Path to Net Zero, October 2021, https://www.mckinsey.com/capabilities/sustainability/our-insights/putting-carbon-markets-to-work-on-the-path-to-net-zero#/
World Bank. 2022. State and Trends of Carbon Pricing 2022. Wash- ington, DC. Available at: https://openknowledge.world- bank.org/handle/10986/37455
Photo Credit for Thumbnail Image: Mining Review.com, https://www.miningreview.com/east-africa/what-to-make-of-the-new-african-carbon-markets-initiative/