Why India Wants To Set Up Its Own Carbon Trading Market — BQ Explains

India is planning to establish a domestic carbon trading market as it looks to reduce emissions and achieve its long-term goal of net zero by 2070.

Prime Minister Narendra Modi's administration has proposed amendments to a 20-year-old energy conservation law that will provide the framework for a carbon market in an attempt to incentivise emission reduction by industries and commercial units.

It wants to start issuing carbon credit certificates to companies which can then be traded through a marketplace mechanism.

Modi is expected to announce the launch of a carbon trading platform which, according to a Bloomberg report, will be first limited to polluting sectors where emissions are hard to cut like oil and gas, cement and steel.

That comes soon after India's cabinet approved Modi's climate pledges made at the COP26 in Glasgow last year. Under India's updated pledge, it aims to have 50% of its energy come from non-fossil fuel sources by 2030 and reduce the emission intensity of its GDP by 45% over 2005-levels.

But carbon markets aren't new and the idea of pricing carbon goes back over two decades.

What Is Carbon Trading?

The Kyoto Protocol in 1997 was the first major global agreement to reduce greenhouse gas emissions amid increasing evidence of climate change being caused by human activities.

That introduced a carbon credits mechanism by letting countries have a level of allowed emissions, which would be counted as assigned units.

The protocol allowed countries that had spare emissions units—that they hadn't used up—to sell the excess to other countries who may have breached the target.

For instance, if a country was assigned 100 units, and its emissions were equivalent to 120 units, then it could pay another country with spare units to buy 20 extra credits. The idea was to incentivise fewer emissions by putting a price on carbon and allowing low emitters to get rewarded for their efficiency.

Over the years, this has seen several iterations across countries and regional blocs with varying effectiveness. According to the International Carbon Action Partnership, as of 2021, there were 25 such emissions trading systems in the world. Another 22 trading systems are under development or consideration.

Emissions trading systems now cover about 17% of the global greenhouse gas emissions, more than triple the amount since 2005, when the European Union launched its own system. The most recent boost to the ecosystem came when China's national system came into effect in 2021, becoming the largest carbon market in the world.

Right now, it is not known what form a carbon market will take in India. Bloomberg reported that the detailed plan will be ready by the fourth quarter.

Has India Attempted This Before?

India has dabbled with ideas that have resembled emissions trading markets.

Abinaya Sekar of the Centre for Policy Research points out that a pilot emissions trading scheme aimed at particulate matter was launched in Surat, Gujarat. It was the first time an ETS was introduced for particulate matter, that denote air quality.

The Gujarat Pollution Control Board set a cap of 276 tonne of particulate matter emissions released by industries over a 46-day compliance period.

A fixed number of tradeable permits were created at the start. 80% of the permit supply was distributed for free among participating industrial units. The remaining 20% of the permits were sold by the GPCB through auctions at a floor price of Rs 5 per kilogram and capped at Rs 100 per kg.

Industrial units were allowed to buy and sell permits from Wednesday to Monday, while prices were set at a price discovery auction on Tuesday.

A preliminary analysis of the scheme found that plants that participated in the market reduced suspending particulate matter emissions by 24% compared to plants that were in a status quo regime.

According to Sekar, some concerns around transparency, reproducibility, state capacity and clarity around the framework still remain. Clean air markets for particulate matter and greenhouse emissions have also been announced in Surat, Ludhiana and Ahmedabad.

Besides this, India has had a scheme in place since 2008 aimed at improving energy efficiency among companies, which consequently leads to lower emissions.

Under the Bureau of Energy Efficiency's 'Perform, Achieve, and Trade' scheme, companies that overachieve energy efficiency targets are awarded certificates which can be traded with units that have not achieved targets.

The Ministry of Power said that it has issued over 57 lakh certificates to 349 units that have saved more energy than the target. It said over 66 million tonne of CO2 emissions have been avoided between 2016 and 2019.

That said, a study by the Centre for Science and Environment found that thermal power plants, which had the most lenient targets, underperformed and reduced emissions by only 3%. The report highlighted the need for more stringent targets.

How Is The Price Of Carbon Fixed?

Countries and companies alike have different ways of setting a price for carbon. These are usually achieved by either putting a carbon tax, or through a market-based approach like an emissions trading system.

While India has no explicit carbon pricing, it does that in the form of levies. The central government's fuel excise taxes and coal cess are two such examples.

According to the Organisation for Economic Co-operation and Development, these implicit carbon prices in India have nearly tripled since 2018.

This way of pricing carbon, however, results in individuals and households bearing the brunt as cost increases due to levies are usually passed on to the end consumer.

But pricing is extremely varied across the globe. According to the World Bank's Carbon Pricing Dashboard, as of April 2022, the price of carbon ranges from as low as $0.5 per tonne of CO2 to as high as $137 per tonne.

What's the right price? There are several estimates. The International Monetary Fund says a floor price of $25-75 per tonne of CO2 is needed. That's much higher than the global weighted average cost of carbon credits in 2021 at around $3.

In India, several companies set their own internal carbon pricing to help them incorporate the impact of emissions in their financials.

The Carbon Disclosure Project said that 85 companies, as of 2021, were either already pricing carbon or were planning to do so in the next two years.

Mahindra & Mahindra Ltd. was the first to adopt an internal price of $10 per tonne. Other prominent companies that do so include ACC Ltd., Ambuja Cements Ltd., JSW Group, Infosys Ltd., Essar Oil Ltd., Tata Chemicals Ltd., Tata Steel Ltd., Tata Motors Ltd., Shree Cement Ltd., Godrej Industries Ltd., and Wipro Ltd., among others.

What's In It For India?

India aims to cut it emissions intensity by nearly half over the next eight years—that means each unit of GDP growth will have to come with significantly less emissions.

Establishing a carbon market and incentivising companies to reduce emissions is one of the ways that can help the country achieve that.

Besides the intended target of lower emissions, carbon markets have evolved to become a lucrative source of revenue too. ICAP estimates that by the end of 2021, global emissions trading systems had raised a record $161 billion in auctioning revenues.

Countries have tended to use this additional revenue to fund their climate programmes, such as those improving clean energy adoption, low-carbon transport and energy efficiency. In some cases, these have also been used as welfare funding for disadvantaged social and low-income groups.

According to S&P, India already has a proven track record in Kyoto Protocol's Clean Development Mechanism that allowed countries to offset their emissions by funding emission-reducing projects in other countries. India has attracted $120 billion of investments under the mechanism so far, representing a fifth of the total global CDM investments.

"A proven CDM track record, sustainable development aspirations and gaps in clean technology access places India as a potentially dominant supplier in the emerging global mitigation market," a note by S&P said.

This could come to India's aid which, according to Standard Chartered, needs about $12.4 trillion to meet its long-term net zero goals without hurting its citizen's cost of living.