Lurking fear of carbon credit oversupply

The government recently notified greenhouse gas emission intensity targets for 282 units of multiple companies in four sectors — aluminium, cement, chlor-alkali, and paper industries — effectively firing the starter pistol for an Indian carbon market.

The notification is essentially for the ‘compliance market’ — namely ‘obligated entities’ must meet the emission targets or make good shortfalls by buying carbon credit certificates and submitting them to the regulator, or attract a penalty. (In contrast, the ‘voluntary market’ is where companies voluntarily bind themselves to emission reduction targets, either due to market pressure or as part of ethical corporate behaviour, and buy carbon offsets from the market when unable to meet their targets.)

The compliance market works as an emission trading system (ETS). An obligated entity (OE) is allowed a certain level of emissions. Issued by the power ministry’s Bureau of Energy Efficiency (BEE), each carbon credit represents one tonne of carbon dioxide, either in terms of avoided emissions or the gas removed from the atmosphere. The certificates can be traded only on power exchanges and their market price is determined by a bidding process, subject to upper and lower limits fixed by the bureau.

“India has moved from intent to implementation,” says Manish Dabkara, Chairman and Managing Director, EKI Energy Services, and president, Carbon Markets Association of India. EKI Energy, a listed company, provides carbon credit facilitating services.

As India enters the portals of carbon trading, it is worth bearing a few points in mind.

The Carbon Credit Trading Scheme, notified by the government in June 2023, named nine sectors for inclusion in the compliance market. While emission intensity targets have been announced for four sectors, the rest — fertilizers, iron and steel, petrochemicals, petroleum refinery, and textiles — have not been covered yet. The nine sectors together account for only 16 per cent of India’s emissions. High-emitting sectors — mainly agriculture and electricity generation — are part of the voluntary market. So, there is a long way to go.

Furthermore, emission intensity targets have been announced for 2025-26 and 2026-27. This is probably the developmental phase, with a focus on experience gathering, data collection, capacity building and fine-tuning policy and institutions.

In a recent paper, experts Abhinav Jindal, senior faculty, Power Management Institute; Shivam Puri, an independent researcher; and Girish Shrimali, head of transition finance research, Oxford Sustainable Finance Group, University of Oxford (UK), recommend a three-phased approach to building carbon markets in India: development phase (2025-27); transition phase (2028-31), where other market instruments such as renewable energy certificates and energy savings certificates (ESCerts) are linked with the carbon market; and full implementation phase (2032-35).

The government’s announcement of emission intensity targets for 2025-27 seems to be in line with these recommendations.

Lessons from the past

India has had experience in carbon trading in the form of two instruments — RECs (issued to renewable energy companies that choose not to sell their energy for a premium); and ESCerts (issued to ‘designated consumers’ under the BEE’s ‘perform, achieve, trade’, or PAT, scheme). Energy efficiency achievements against a set target earn the designated consumers tradable ESCerts.

Now, as India rolls into carbon credit trading, it is necessary to learn from the REC and ESCert experience.

Oversupply of ESCert

Is the government’s unit-wise GHG emission intensity target easy or stiff? An easy target would defeat the purpose, while a stiff one could lead to inflation, as companies build the high cost of compliance into their selling price. Target setting is, therefore, the most critical aspect of carbon trading.

Jindal, Puri and Shrimali dwell on this aspect in detail in their paper. “One of the major learnings from PAT market is their lax targets, where several industrial sectors including power sector entities, overachieved their targets, leading to huge oversupply of ESCerts, which needs to be corrected with the Indian ETS,” the paper cautions, noting that target setting requires extensive consultations and negotiations with industry representatives, and should be based on robust empirical allocation methodologies.

Dabkara wants the government to act as a market stabiliser, buying credits from the markets in case of an oversupply and selling them in the international markets.

Transparency

Then there is the aspect of enforcement. For years after the introduction of RECs, renewable energy companies held heaps of them without enough buyers, as the various State electricity regulatory commissions hesitated to enforce the mandatory renewable purchase obligation. Jindal, Puri and Shrimali note that in the PAT market, entities initially did not comply with the regulation as they failed to buy the ESCerts, while the regulator failed to penalise these entities. “Penalty is an important feature proposed by this study, which should be strictly imposed to avoid incidences of non-compliance and delayed compliance by entities in the Indian ETS,” the paper says.

Then there are issues related to the integrity of carbon credits. India has been a major exporter of carbon credits. Tata Power notes in its comments to the carbon credits regulations that India accounts for 30 per cent of the global inventory of carbon credits. BEE’s standards for issuing carbon credit certificates to voluntary market players should inspire confidence on the authenticity of the emission reduction claims. Eventually, the Indian carbon market would have to be linked with global markets to attract more participants, leading to more liquidity and stability. As such, at the regulatory level, India would need to adhere to international standards and work closely with other leading carbon markets and institutions, say Jindal, et al. They say it is important for the Indian carbon market to set transparency benchmarks, ensuring that all data related to targets, emission reductions, and allowance issuance is readily accessible to the public.