Baba’s Explainer – Carbon trading policy

  • IASbaba
  • September 2, 2022
  • 0
Economics, Environment & Ecology, Governance
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  • Environmental Conservation
  • Government policies and interventions for development in various sectors and issues arising out of their design and implementation

India is currently the third largest carbon emitter in the world, behind the US and China.

What is the Energy Conservation (Amendment) Bill 2022?

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, which has powered the first phase of India’s shift to a more energy-efficient future.

The Bill to amend the Energy Conservation Act, 2001 –

  • 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.

Importantly, the amendment Bill seeks to widen the scope of energy conservation to include large residential buildings as well. Till now, the energy conservation rules applied mainly on industrial and commercial complexes.

At the 2021 United Nations Climate Change Conference (COP26) summit in November 2021, India promised to reach zero carbon emissions by 2070 and reduce its emissions by one million tonnes in the next 10 years. Establishing a carbon credit market is the first step toward this goal.

Carbon Emission (CE)

  • Occurs during the burning of carbonaceous fossil fired fuels, or in industrial manufacturing processes of cement, steel, chemicals etc.
  • CE can be eliminated by substituting energy source/fuel- renewable solar/wind energy for thermal power; electric vehicles for petrol/diesel vehicles; and domestic electric appliances instead of kerosene/gas.
  • However, industrial processes where the nature of chemical reaction is such that carbon dioxide is an inescapable output, such as in the production of cement clinker or iron in blast furnaces or chemicals and petrochemicals, CE can at best be reduced with better process efficiency.
  • For example, India’s cement industry is perhaps the most efficient in the world with the emission intensity reduced to 576 kg of CO2 per tonne of cement against the global average of 634 kg but has limited potential for further process efficiency and continues to be a HtAS.
What is a carbon market?

Emission reductions and removals are converted into tradable assets through a carbon market. This implies that an industrial unit that surpasses the emission criteria is eligible to receive credits. Additionally, it would allow struggling units to purchase credits and demonstrate compliance.

  • In simpler terms, a carbon market will create incentives to reduce emissions or improve energy efficiency.
  • These commitments would drive demand for voluntary carbon credits in India.
  • The annual demand for voluntary carbon credit in India is expected to touch 500+ million units by 2030
  • 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.

Case Study: In California, US imposes a limit on the volume of greenhouse gases that can be generated by a specific industry or area of the economy. The amount of metric tonnes of carbon dioxide that businesses can emit is then allowed. Businesses that pollute less than their allotted amount can sell the excess to other companies, encouraging everyone to reduce emissions more quickly.

  • 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.
How is the price of carbon fixed?

Global experience suggests that carbon pricing is initially introduced in high carbon-intensive sectors such as power, and then its scope is extended to other carbon-intensive sectors, such as cement and metals, over some time.

  • Currently, India does not have a cap and trade policy or an explicit carbon price. The country has an implicit pricing structure defined by Internal Carbon Pricing (ICP).
  • As per the Carbon Disclosure Project (CDP), ICP is a voluntarily determined price used within an organization to value the cost of one unit of CO2 emission. This reflects the carbon market price in the region where the company operates.
  • According to a report titled ‘ESG India by Kotak Institutional Equities’, companies, especially in carbon-intensive sectors, and lower emission alternative providers will see an impact.
  • Other than that, companies in the renewable energy sector will grow, and the revenue prospects of companies that manufacture equipment/render services which support carbon-intensive sectors and activities will also increase.

Carbon markets will also open up new horizons for companies engaged in developing/consulting/trading carbon credits. On the other hand, it will be detrimental to the prospects of coal-based power generation capacities and Coal India’s growth ambitions.

What are the benefits of adopting carbon trading policy?

Any emission reduction is a step closer to tackle global warming and carbon trading scheme helps in the same.

  • It achieves the objective of GHG emission reduction at low cost with caps in emissions, sanctions in the form of trade and fines as seen in Kyoto protocol.
  • It helps in more effective way to address the global warming with the development of new technologies and technology transfer to utilize the renewable energy potential. E.g. Hydro electric project investments in countries like Bhutan by India.
  • Emission trading provides a way of establishing rigour around emissions monitoring, reporting and verification – essential for any climate policy to preserve integrity.
  • Emission trading results in a synergetic effect by way of integrations and collaborations and collective effort to fight the climate change. E.g. an industrial area in a third-tier town may not be able to contribute to climate change if not collaborations with global companies which is facilitated by the emission trading.
What is the efficacy of carbon trading policy?

The carbon trading market revolves around the presence of:

(a) permissible threshold limits of CE for each industry,

(b) market players’ success at decarbonisation, reducing CE to below threshold levels, and/or attained lower net CE by investing in carbon sequestration or afforestation,

(c) polluting/inefficient market players whose CE exceeds the permissible threshold levels, and

(d) pricing mechanism that acts as an incentive for sale of credits by efficient market players and purchase of credits by inefficient market players.

  • According to the Paris agreement, the UN Panel on Climate change has indicated a price range of $40-80 per tonne of carbon dioxide if global warming is to be pegged within 2 degrees by 2050.
  • The idea of a carbon market presupposes that market dynamics will enable optimum price discovery that is a deterrent for polluters and incentive for entities who invest on protecting the environment. This objective does not appear to have been realised so far.
  • Although, these are early days, if the proposed carbon market in India does not become vibrant and robust quickly, there is a danger that HtAS will buy carbon credits at low prices and continue to increase their CE defeating the very purpose of a market linked mechanism that determines a deterrent cost for pollution.

Hence, it is to be hoped that the carbon trading policy including the permissible threshold limits in each industry are carefully crafted to meet the twin objectives of growth and quality of life.

What are the concerns with the carbon trading policy?
  • It becomes ineffective if the companies have the wherewithal to invest heavily offsetting the carbon price they pay.
  • Determining physical actions that companies must take, with no flexibility, is not guaranteed to achieve the necessary reductions.
  • Establishing a regulated price is a policy nightmare and take years to come to a consensus and also faces a backlash. E.g. Carbon cess.
  • As accounting the exact emissions is difficult, the issues in emission counting rendered by the developed countries has resulted in just number magic rather than actual reduction in emissions.
  • Creating a market in something with no intrinsic value such as carbon dioxide is very difficult.
  • The low carbon pricing mixed with politics has made the scheme ineffective where in the overall emissions have increased rather than decrease.
Why Carbon Markets in significant for India?

A report from Deloitte Economics Institute highlights that India must act now to prevent the country from losing $35 trillion in economic potential over the next 50 years due to unmitigated climate changes. The report also reveals how the country could gain $11 trillion in economic value over the same period by limiting rising global temperatures and realising its potential to export decarbonisation.

Indian companies have already been participating in the global carbon market. This is done through one of three modes — carbon neutrality, Renewable (RE 100), and Science Based Targets (SBT).

  • Companies participating in RE100 and SBT work to lower their emissions directly by reducing their reliance on harmful activities.
  • Businesses that practise carbon neutrality invest in carbon offsets to achieve an equivalent decrease.
  • Both domestic and foreign markets are sourced for the acquisition of these offsets.
  • Though the market will largely be voluntary to begin with, once it becomes mandatory for a specific sector, the scheme will remain open for the Indian voluntary market buyer as mentioned in the Bill. This will open the market for newer avenues even as the demand for voluntary carbon credits grows exponentially in the country

Clean Development Mechanism (CDM) of the Kyoto Protocol

  • 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.
What are the limitations of the PAT Scheme?

The Perform, Achieve and Trade (PAT) Scheme is a programme launched by the Bureau of Energy Efficiency (BEE) to reduce energy consumption and promote enhanced energy efficiency among specific energy intensive industries in the country.

According to the government, the scheme has led to energy savings of about 17 million tonnes of oil equivalent and resulted in the mitigation of about 87 million tonnes of carbon dioxide per year. A tonne of oil equivalent is the amount of energy released by burning a tonne of crude oil.

An analysis by the Centre for Science and Environment (CSE), a Delhi-based a public interest research and advocacy organisation, however, found that the scope of these reductions could have been far greater if industries were given higher targets and the scheme were implemented more thoroughly. For example, in the thermal industry, the CSE found that energy savings were only 3 per cent of the industry’s total annual emissions.

  • By reducing energy consumption below a threshold limit that begets tradeable energy certificates (each certificate is for reduction of 1 MWH over a set target), an entity indirectly reduces CE and concurrently earns revenue. However, the PAT scheme does not incentivise efforts for the major direct CE reduction in ‘hard to abate sectors’ (HtAS) emanating from industrial chemical processes.
  • Over and above improvement of energy efficiency, HtAS would entail R&D-led alternative technologies/processes, or substitution of raw materials, the technical feasibility and commercial viability of which are yet to be established. Hence, as such, there is no potential for additional benefit from the PAT scheme for most cement plants in India.
  • Further, an integrated steel plant switching from the conventional blast furnace route to scrap based electric furnace steelmaking, may increase its electricity consumption but substantially reduce CE (by elimination of coke required for blast furnaces), would not qualify for energy certificate in the PAT scheme. The scope of the PAT scheme being limited, only 70 million tonnes CE reduction (2.5 per cent total CE) was possible at the end of PAT-II cycle in 2019-20.
What is the way ahead?

India is no stranger to carbon credits, which it has accumulated through participation in Clean Development Mechanism (CDM) projects. The strong experience in CDM projects has helped India develop projects that qualify for Voluntary Carbon Credits. However, compared to developed markets like the US, Voluntary Carbon Credits market in India is still in its infancy.

  • There is a need for regulatory frameworks and policy guidelines that provide clear mandates on emission reductions.
  • A new carbon trading system must be accompanied by proper pricing of credits for it to act as a check on hardcore polluters.
  • Both the Centre and State need to figure out a way to bring large buildings under the law – since power is a subject that both states and the central government have jurisdiction over. For the changes to be truly effective, they need to be enforced by state governments at the local level

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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