Baba’s Explainer – Carbon Markets

  • IASbaba
  • August 5, 2022
  • 0
Environment & Ecology
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  • GS-3: Environmental Conservation

Context: In order to facilitate the achievement of more ambitious climate change targets and ensure a faster transition to a low-carbon economy, the government is seeking to strengthen a 20-year law, called the Energy Conservation Act of 2001.

The Bill to amend the Energy Conservation Act, 2001 has two main objectives.

  • First, it seeks to make it compulsory for a select group of industrial, commercial and even residential consumers to use green energy. A prescribed minimum proportion of the energy they use must come from renewable or non-fossil fuel sources.
  • Second, it seeks to establish a domestic carbon market and facilitate trade in carbon credits.
What are carbon markets?
  • The creation of a domestic carbon market is one of the most significant provisions of the proposed amendment Bill.
  • Carbon markets allow the trade of carbon credits with the overall objective of bringing down emissions.
  • These markets create incentives to reduce emissions or improve energy efficiency.
  • For example, an industrial unit which outperforms the emission standards stands to gain credits. Another unit which is struggling to attain the prescribed standards can buy these credits and show compliance to these standards. The unit that did better on the standards earns money by selling credits, while the buying unit is able to fulfill its operating obligations.
  • Under the Kyoto Protocol, the predecessor to the Paris Agreement, carbon markets have worked at the international level as well.
    • The Kyoto Protocol had prescribed emission reduction targets for a group of developed countries.
    • Other countries did not have such targets, but if they did reduce their emissions, they could earn carbon credits.
    • These carbon credits could then be sold off to those developed countries which had an obligation to reduce emissions but were unable to.
    • This system functioned well for a few years. But the market collapsed because of the lack of demand for carbon credits.
  • A similar carbon market is envisaged to work under the successor Paris Agreement, but its details are still being worked out.
  • Domestic or regional carbon markets are already functioning in several places, most notably in Europe, where an emission trading scheme (ETS) works on similar principles.
    • Industrial units in Europe have prescribed emission standards to adhere to, and they buy and sell credits based on their performance.
  • China, too, has a domestic carbon market.
  • A similar scheme for incentivising energy efficiency has been running in India for over a decade now. This BEE scheme, called PAT, (or perform, achieve and trade) allows units to earn efficiency certificates if they outperform the prescribed efficiency standards
    • However, the new carbon market that is proposed to be created through this amendment to the Energy Conservation Act, would be much wider in scope. Although the details of this carbon market are not yet known.
What are the other ways of pricing carbon?

A smart approach is pricing carbon which can be done in following ways:

Emission Trading

  • One way to price carbon is through emission trading, i.e., setting a maximum amount of allowable effluents from industries, and permitting those with low emissions to sell their extra space.
  • It is a market-based approach to controlling pollution by providing economic incentives for reducing the emissions of pollutants.
  • This is in contrast to command-and-control environmental regulations imposed by governments

Carbon Tax

  • Another way is to put a carbon tax on economic activities — for example, on the use of fossil fuels like coal, as done in Canada and Sweden.
  • A carbon tax is a fee on the carbon content of fossil fuels
  • It is a powerful monetary disincentive that motivates transition to clean energy across the economy, simply by making it more economically rewarding to move to non-carbon fuels and energy efficiency.
  • Example: Canada imposed a carbon tax at $20 per tonne of CO2 emissions in 2019, eventually rising to $50 per tonne. This is estimated to reduce greenhouse gas pollution by between 80 and 90 million tonnes by 2022.
  • The fiscal gains from pricing carbon can be sizeable. A carbon tax at $35 per tonne of CO2 emissions in India is estimated to be capable of generating some 2% of GDP through 2030.

Carbon Tariff on Imports

  • Big economies like India should also use their global monopsony, or the power of a large buyer in international trade, to impose a carbon tariff as envisaged by the EU
  • Focusing on trade is vital because reducing the domestic carbon content of production alone would not avert the harm if imports remain carbon-intensive
Why Carbon Markets in significant for India?
  • Developing countries, particularly India, China and Brazil, gained significantly from the carbon market under the Clean Development Mechanism (CDM) of the Kyoto Protocol. 
  • India registered 1,703 projects under the CDM which is the second highest in the world. Total carbon credits known as Certified Emission Reductions (CERs) issued for these projects are around 255 million amounting to S.$2.55 billion.
  • Therefore, logically, India has a lot to gain from a thriving carbon market. However, with the ratification of the Paris Agreement, the rules of the game have changed.
  • Unlike the Kyoto Protocol, now even developing countries are required to have mitigation targets.
  • Developing countries are faced with a dilemma of either selling their carbon credits in return for lucrative foreign investment flows or use these credits to achieve their own mitigation targets.
  • This has made Article 6 a highly sensitive issue that requires careful balancing of interests and expectations.
  • While over 50% of the countries have communicated their intention of using market mechanisms to achieve NDC targets, India is not one of them as it aims to rely on domestic mitigation efforts to meet its NDC goals.
  • It is the developed countries that would rely more on market mechanisms for achieving their climate targets as they would be comparatively low-cost options.

Mains Practice Question – What are carbon markets? What role does carbon markets play in achieving India’s climate targets?

Note: Write answers to this question in the comment section.


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