Should rich countries get to buy up India’s valuable carbon savings to balance out their carbon footprint or should the government use them to meet its climate change targets under the Paris climate change agreement? This Hamletian dilemma has hit the government as it builds the country’s first formal market for carbon trading.

So, it has decided to take it slow and delay answering the question.

India’s carbon market journey will begin with a government-run voluntary carbon market in which companies set emission targets for themselves and trade their carbon savings in a market set up by the government. In this voluntary trading, there is no emission cap that companies need to comply with but are seeking to meet internal target in reducing carbon footprints. Then, India plans to graduate to a compliance market where companies are given emission targets and over-emitters will have to buy carbon savings from the market to compensate for excess emissions. And eventually, go global by allowing other countries to buy India’s carbon savings to top up their emission quota.

However, this carbon market isn’t a debut show for India. The new carbon market is rising from the ashes of a failed attempt at creating a proxy market for carbon trading. We call it a proxy market because in this market, energy-efficiency savings by select industries were traded, though it did indirectly lead to carbon savings too. But the market collapsed. 

In this analysis we explain why the cautious steps taken by the government in setting up the carbon market are also fraught with the risk of failure.

The Reporters’ Collective reviewed government plans and reports, and spoke to government officials involved in establishing the carbon trading system. The officials spoke off the record to be more candid. We also spoke to experts outside the government who have been part of official discussions.

But first, what is a carbon market?

Let’s say, for every 1,000 tonnes of steel a company produces, it emits 100 tonnes of carbon dioxide from burning fossil fuel. To reduce carbon emissions, the company invests in a new technology that burns less fossil fuel for every tonne of steel it produces. It makes a carbon saving.

What if the company could sell this ‘savings’ to others and recoup some of its investment? There are companies that are finding it difficult to invest in carbon-saving technologies but are also under obligation (or voluntary target) to reduce greenhouse gas emissions. They buy this ‘carbon saving’ and take credit for the reduction in emissions against their targets.

There comes the idea of a carbon market where those who have reduced their emissions earn savings, and those who have exceeded their emission limit get to buy savings from others, and match their needs or targets.

The supply and demand decide the price at which such carbon savings are sold in the form of fungible certificates called carbon credits. One carbon credit is equivalent to one tonne of saved carbon emissions. The idea, at least on paper, is that this reduces the overall cost of bringing down greenhouse gas emissions.

Why do people advocate for a carbon market?

Not everyone is a fan of market-based carbon trading. Critics argue that it allows emitters to buy their way out of emission violations. But advocates of carbon market say it helps finance the adoption of efficient low-emissions technologies.

An international carbon market would help low-income and developing nations get the money for the investments they make towards bringing down emission, they contend. Carbon credits generated in India could be sold to foreign entities that emit more greenhouse gases than they are supposed to.

The Paris Agreement, which 196 countries, including India, signed in 2015 sets the broad framework under which such international trade in carbon emissions can be carried out and accounted for. But there is a catch in carrying out such international trading of carbon emissions by developing countries.

The challenge of selling carbon credits abroad

India has also committed to reducing its emissions under the Paris Agreement. To achieve this target, it would have to put in place different targets for its industries, transport sector and power producers to reduce their carbon footprint.

But, if these industries were to sell these carbon savings achieved by reducing emissions to foreign entities, then India as a country would not be able to add the carbon savings to its account. It would have to work hard to make up for the savings sold abroad. This is done to prevent “double counting” of emission reduction.

Imagine, India reduces emissions by 100 tonnes next year. But the industries sell 25 tonnes of carbon savings to a foreign company with big pockets. The Indian industries might make some money out of it but the average Indian citizen would have to pay the price for the costlier additional 25 tonnes of emission reduction the country has to undertake. The cost to the economy, as they call it.

“We are yet to decide what kind of carbon credits we would allow to be sold internationally. It is tricky. A market does not follow national interest, it has its own logic and ways. The international market will look for the cheapest carbon credits to buy – something cheaper than undertaking emission reduction themselves. To safeguard India’s interest and to allow a mature market, to do both, is a difficult task,” a senior official in the Union ministry of environment, forests and climate change told us.

This official and several others we spoke to expressed concerns that India would always remain a ‘net supplier’ of carbon credits. “The demand will always be higher in developed countries. So Indian companies would fetch better prices for their carbon credits internationally. They will naturally want the international market to be open,” one of them explained. 

This chasm between what is in national interest and what a market-based tool of carbon trading requires was reiterated by another official who deals with the Indian government’s international engagement on climate change.

Then there is the question of when and whether a mature international market for carbon credits will emerge. “Tomorrow if a republican government comes into power in the US and draws down its ambition on reducing emissions, one of the biggest potential markets where Indian entities could sell their targets will just melt away. There is too much vagueness at the moment,” said the official. 

To postpone finding an answer to this conundrum (and, India has time to do so), in the second phase of the carbon market India develops, the government wants to run a domestic market.

Domestic market

A domestic carbon market would be a place where Indian entities trade emissions with each other. All emission reductions would be counted towards India’s targets or Nationally Determined Contributions, as they are called under the Paris Agreement.

The Union government has been planning this for a while. The Indian Electricity Conservation Act, 2001 was amended in 2022 to create a legal regime for it.

In August 2022, while tabling amendments to India’s electricity conservation law, Union Power Minister R. K Singh said there would be a ban on export of carbon credits. Invest India reported that the Minister sought the ban to ensure that the emission reduction is counted towards India’s NDCs. 

He flipped his position within months. In October 2022 he was quoted saying, “We are not looking to ban (carbon credits). The ban will only be up to the extent required for our own NDCs (Nationally Determined Contributions, the technical phrase for India’s emission reduction targets under the Paris Agreement).”

Another February 2023 article by the Confederation of Indian Industry (CII), said that even though India stands to gain from an increasing global voluntary carbon trade, the Indian government will halt export of carbon credits to focus on accomplishing its own climate goals under the Paris Agreement.

In March 2023, the Bureau of Energy Efficiency, which works under the Union power ministry, brought out the draft of the Carbon Credit Trading Scheme or India’s carbon market for comments. It is soon going to implement a national carbon market, which would initially be voluntary.

Going initially for a domestic carbon market may help postpone the challenges of opening the market to international players but it presents India with a second layer of policy concerns. Some of them emanate from the failures in the past experiments.

The PAT scheme

Long before India agreed to reduce its emissions under the Paris Agreement and be part of an international trade in carbon, it experimented with a market-based climate solution.

It set up a market to trade in ‘energy saving certificate’ in 2012. It was named the PAT scheme (“Perform. Achieve. Trade”). Under PAT, energy efficiency targets are set and have since covered over 13 large, organised and energy-intensive industrial sectors such as aluminium, iron & steel, thermal power plants, fertiliser and the hotel industry. It works like a proxy for a carbon savings market because when industries save on energy, their emissions also get reduced.

If a company saves more energy per tonne of its produce, it is permitted to sell the savings to others who are not able to achieve their targets.

In its first 3-year cycle, PAT achieved savings of 8.67 Million Tonnes of Oil Equivalent (mtoe) against the target of 6.686 mtoe, according to the Bureau of Energy Efficiency (BEE).

The savings seem to suggest the scheme was a grand success. Not so. PAT, by the government's own admission, flopped. 

The standards were so low that achieving targets was a walk in the park for industries. The demand plummeted and certificates flooded the market. There were more suppliers in the market for the energy saving certificates than there were buyers.

Bureau of Energy Efficiency reported the oversupply of energy saving certificates in the PAT scheme.

By the end of each PAT cycle, millions of Energy Savings Certificates or ESCerts remained unsold, according to BEE’s ‘Draft Blueprint on “National Carbon Market” published in 2021. The government initially had set an expiry date for these certificates. With the market collapsing, they extended the lives of these certificates in the hope that industries that had generated them will someday sell and recoup some money. It didn’t happen.

This is the classic case of a government wanting to keep carbon or energy-efficiency standards low so that industry does not get burdened by the cost of going green. This happened in the European Union too, when they first ran a carbon market. The low standards caused the prices of the carbon to crash.

So, the Indian government has decided it will go slow even on a regulated, standards-based or as it is sometimes called compliance-based market and will first launch a voluntary carbon market.

In this, no carbon savings targets would be set for industries. 

In its policy paper on establishing a carbon market in India, BEE maintains that in order to overcome the challenges faced by PAT, it will follow a three-phase approach: It will increase demand in the voluntary market, then increase supply and finally it will transition to a cap and trade or compliance system.

The three-phased approach proposed by the Centre for India’s carbon market.

Experts we spoke to rubbished this method. 

“The policy paper talks about managing supply and demand. There is no question of that since a market regulates itself. If there is oversupply, the prices will fall and vice versa,” said Dr Prodipto Ghosh, the former Secretary in the Ministry of Environment and Forests and distinguished fellow at The Energy and Resources Institute (TERI).

“The market is a self-adjusting creature and that is something we need to understand,” he added.

We sent queries to the Ministry of Power, the Ministry of Environment, Forests and Climate Change and the Bureau of Energy Efficiency seeking comments on why India has decided to set up a voluntary market, how it plans to start international trade and how it plans to address the challenges of the PAT scheme as it shifts to a compliance market.

They haven’t replied yet. We will update the copy when we hear from them.

Voluntary market

In January 2023, Abhay Bakre, the Director General of Bureau of Energy Efficiency (BEE), said in an interview that while India will launch this year its voluntary carbon market, it will take a couple more years to establish a compliance market.

In a voluntary carbon market entities voluntarily trade in emissions with no government-imposed target to comply with. But in a compliance market, the government sets limits on emissions for industries.

Indian entities have been participating in the global voluntary market, as stated earlier. Issues with the voluntary markets have been highlighted in the past -- like fake credits and inefficient audits to establish emission reduction. Global watchdogs have called for stricter regulations to prevent this.

But the voluntary market is governed by market dynamics and interactions between private entities trading credits issued by independent verifiers like Gold Standard and Verra. In India, these are big corporations that fulfil their climate obligations in an international set-up for competitive advantage to attract climate-conscious investors.

Experts we talked to expressed lack of clarity on reasons behind the government's foray into this private trading when its primary job involves setting up a mandate under India’s Nationally Determined Contributions.

Voluntary markets are supposed to function among entities that are not bound by any targets, outside the ambit of compliance to reduce emissions.

“If you want to set up a domestic carbon market, what is the use of government regulation unless you want to have a mandate in the first place? If it is purely voluntary, why do you want to replicate an existing system,” said Ghosh.

“Why would a company go to the Bureau of Energy Efficiency (that will regulate the domestic voluntary carbon market) if the Gold Standard is available and the existing market is already well established. Why would the government get into a voluntary carbon market if no other government has?” he added.

Another expert (who requested anonymity) told us that the government’s job is to prescribe targets to reduce emissions, which means creation of a compliance market. “It should set targets for Indian industries to achieve. Once India has achieved its own national targets in a particular period of commitment, the excess certificates can be sold in the international market. Parallelly, the entities wanting to trade voluntarily could do so, as they have,” he recommended. 

All the experts we spoke to had the same question: why would a government enter a voluntary market? Some told us that while the government is developing sector-specific emission targets, it wants to also be seen intentionally as a climate change leader, especially after China launched its Emissions Trading Scheme in 2021. 

But posturing may not be enough to reduce emissions. On June 22, 2023 the power secretary was quoted saying that the legal framework- rules and regulations for the carbon market will be out within two weeks.