How India can build a strong and successful carbon market

India took a significant step in its decarbonisation journey last year by notifying the Carbon Credit Trading Scheme (CCTS) under the Energy Conservation Act, 2021 which outlined the broad institutional framework for carbon trading. The CCTS was amended in December 2023, allowing the establishment of a voluntary carbon market. Subsequently, the Bureau of Energy Efficiency (BEE) issued detailed procedures for implementing the CCTS and accredited verification agencies.

However, while these regulatory advances are promising, there remains considerable work to be done before the carbon market can be made fully operational. The key task ahead is to establish industry-specific baselines and emission reduction trajectories. These will provide the foundation for the cap-and-trade system that the market will operate on. Furthermore, Central Electricity Regulatory Commission (CERC) also has to frame the necessary regulations to facilitate carbon trading in power exchanges. Meanwhile, there are some critical aspects that must be addressed to ensure the effectiveness and longevity of the carbon market.

Balancing supply and demand

For a successful carbon market, maintaining a balance between supply and demand for carbon credits is crucial. Else it could lead to very high or very low prices that undermine the efficacy of the market and discourage participation. To prevent such a situation, there must be measures to enforce stringent compliance. The compliance targets themselves must be ambitious yet achievable. Establishing a clear demand for carbon credits will help in maintaining a healthy balance and motivating both suppliers and buyers to participate in the market. In this regard, we can draw valuable lessons from our experiences from Renewable Energy Certificate (REC) and Energy Saving Certificates (ESCerts) markets where the mismatch between supply and demand have posed challenges in the past.

Monitoring and compliance

A strong monitoring and compliance framework is crucial for a successful carbon market. Traditionally, though, these have been observed to be weak points. Laxity in enforcement can affect the sanctity of a market over time. For the carbon market to succeed, it is vital to have a strong monitoring and verification framework and ensure that all participants are accountable for meeting their carbon reduction targets. Leveraging digital technologies, such as blockchain etc., could enhance transparency and traceability within the carbon market, making it more difficult for participants to manipulate data or evade compliance. Without rigorous compliance, the integrity of the market will be at risk, undermining its effectiveness in driving decarbonisation.

Fungibility with ESCerts and REC markets                                                                                  

The CCTS procedure indicates that the Perform, Achieve, and Trade (PAT) scheme, which governs Energy Savings Certificates (ESCerts), will gradually be subsumed into the carbon market. However, there is no clarity on how the existing Renewable Energy Certificate (REC) mechanism will be integrated into this new framework. The procedure has specified that purchasing RECs will no longer count as reducing Greenhouse Gas (GHG) emissions. There are concerns that this might de-incentivise the purchase of RECs. A clear roadmap for the integration of RECs into the carbon market, including timelines and specific mechanisms, is essential to provide certainty to market participants. It is very important that the transition between these schemes is smooth and well-communicated to avoid any market disruptions.

Role of Voluntary Market

The amendment to the CCTS allows non-obligated entities to register their projects and earn carbon credits on a voluntary basis. However, the BEE is yet to finalise the procedures for this voluntary market. This raises questions over how these voluntary credits will interact with the cap-and-trade market and whether obligated entities will be able to use voluntary credits to meet compliance requirements. Since the REC market will co-exist with the carbon market, it also remains to be seen whether a Renewable Energy (RE) generator can participate in both. Previously, the distinction between RECs and Renewable Purchase Obligations (RPO) was based on capacity. The new system, however, focuses on energy consumption, which has brought flexibility in the market and incentivised RE developers to utilise either of the mechanism based on the requirement. Clear guidelines are needed to ensure that the voluntary market complements, and does not compete with, the compliance-driven carbon market. Allowing obligated entities to use a limited percentage of voluntary credits for compliance could stimulate the voluntary market while ensuring the integrity of the cap-and-trade system.

Integration with global markets

For the domestic carbon market to thrive, it must be integrated with global carbon trading mechanisms. There is high demand for carbon credits in international markets, particularly in European Union due to their stringent climate policies. Other geographical areas viz. Singapore, Middle East etc are also emerging as hub for carbon trading. To tap into this demand, India must harmonise its carbon standards with global ones, including Measurement, Reporting, and Verification (MRV) processes and conversion factors. This will not only enhance its credibility but also open doors for international investment and cross-border trade of carbon credits. It will also improve the liquidity and stability of the market and provide an additional source of funding for India’s decarbonisation efforts. India's participation in the upcoming COP29 in Baku in November 2024 presents a strategic opportunity to negotiate and influence carbon trading standards under Article 6 of the Paris Agreement. By advocating for globally compatible standards, we can secure a stronger foothold in international carbon markets, unlocking both economic and environmental benefits.

Policy and regulatory certainty

Like with any other market, stability in policies and regulations is essential for the success of the carbon market. We have seen how in the past the REC and ESCerts markets have got disrupted due to policy and regulatory uncertainties. The REC market was suspended for nearly a year due to issues related to imposition of floor and forbearance prices, and ESCerts prices collapsed when market rules failed to account for supply-demand imbalances. While floor prices have since been introduced, they remain too high for some buyers to absorb. Such incidences have the potential to erode the confidence of the market participants’ affecting the liquidity and efficiency of the market. To prevent similar disruptions in the carbon market, there should be clear, consistent rules regarding pricing, compliance, and enforcement.

India’s carbon market has the potential to be a cornerstone of the country’s decarbonisation strategy, helping it meet its climate goals while driving economic growth. For this, the market must be built on balanced supply and demand, strong compliance mechanisms, smooth integration with the existing markets for REC and ESCerts, and alignment with global carbon trading standards. By laying strong foundations and ensuring policy and regulatory stability, India can create an efficient and credible carbon market that will accelerate its decarbonisation efforts and place it at the frontlines of the global fight against climate change.

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