The domestic carbon market of India is getting closer and closer to becoming a reality as a result of the passage of the Energy Conservation (Amendment Bill), 2022, in the House of the People (Lok Sabha) of the Indian Parliament on August 8th.

The overarching objectives of the bill are to discourage the use of fossil fuels, encourage the use of clean energy, expand the scope of energy conservation, and help India meet its climate change commitments. Stakeholders in the industry have also been anxiously waiting for clarification on the formation of carbon markets in India and laws and regulations for the carbon trading programme. While the bill has cleared the path for carbon markets in India, the essential issues surrounding carbon markets are yet to be addressed. On the other hand, the Hon’ble Minister’s comment about carbon credit export curbs till India reaches its climate objectives has suddenly emerged as a crucial focus point before the anticipated launch of India’s carbon market. India is regarded as the major beneficiary, accounting for around one-third of the global carbon trading via the Clean Development Mechanism (CDM) and voluntary market, which is estimated to generate at least a billion dollars over time.

Before drawing further conclusions on the export ban of carbon credits, we must examine a few things.

1. The export ban may be limited to the renewable energy sector.

The Energy Conservation (Amendment) Bill, 2022 proposes a domestic ‘Carbon Credit Trading Mechanism’ in the country. It empowers the Indian government and other authorised agencies to issue Carbon Trade Certificates to ensure the country’s smooth carbon trading mechanism. The bill intends to subsume all present tradeable certificates, such as Energy Saving Certificates (ESCerts), under Perform, Trade and Achieve scheme. Renewable Energy certificates (RECs) to let entities meet their obligations. The proposal also proposes a closed market that doesn’t allow the export of such carbon certificates in international carbon markets.

First, given that the Energy Conservation (Amendment) Bill, 2022 aims to bring the energy sector into the carbon market largely, it seems that the export prohibition on carbon credits might have an immediate effect on the credits created by the renewable energy sector, many of which are of low-hanging fruit and it is natural govt will put forward a framework for partial or full restriction of export of carbon credits from these sectors in the context of current NDC, with a specific focus on issues associated with “corresponding adjustment”. As per the updated NDC, India aims to reduce the emissions intensity of its GDP by 45% by 2030 from 2005 levels and achieve 50% of total installed power capacity from non-fossil fuel-based sources by 2030. While the detailed framework is some distance away from considering this level of detail, it appears govt is already thinking ahead on what options exist for accounting under Article 6.

With the beginning of domestic carbon trading, the focus will be on the eligibility criteria for creating a domestic carbon market apart from the credit already qualified under RECs and ESCerts. The question will be whether carbon credits from an existing system such as CDM, VERRA VCS, GS will be qualified under the next carbon market and, if so, how and its implication in the context of domestic demand. Even though it is expected that SBTi and CDP compliant companies will partly create specific initial demand, the size of the domestic carbon market on the demand side is still small. This requires building a solid base for creating market demand for carbon credits among domestic players.

2. The future of the voluntary carbon market depends on the policy framework and COP27.

It is possible that the Indian government will propose a new framework which will make many of the existing low-hanging credits from RE projects ineligible to participate in the domestic carbon market. If allowed, it will significantly influence the long-term viability of credits derived from PAT (Perform, Achieve, and Trade) and REC (Renewable Energy Certificates) and could hinder the ongoing effort to incorporate them into a new carbon market structure.

Moreover, voluntary demand for carbon credits from the Indian market is relatively low today. Any policy discretion enabling existing or similar qualified carbon credits at par with the existing PAT and REC trading systems under the current scenario would drive down the price of REC and ESCerts (Energy Saving Certificates). Thus, the policy framework is needed to distinguish the credits from the different segments and to integrate all the credits having a timeframe of 5 to 10 years.

Suppose the proposed framework for the future carbon market does not have the flexibility to accommodate voluntary carbon market standards. In that case, a large number of projects that are currently operating under the voluntary carbon market standard will cease to exist. Therefore, the carbon market’s fairness, credibility, and sustainability will be tested in a major way over the next few months. There is a catch if it will be allowed, it will flood the domestic carbon market which is almost non existence as of today.

We need to look into the outcome of COP27 where many of the open-ended questions still linger in the context of the voluntary carbon market. Today, it ultimately falls on the voluntary carbon credit buyers to determine whether they wish to accept and use voluntary market units that do or do not have a corresponding adjustment in relation to their respective corporate claims. This critical point will come to the forefront in Article 6.4 framework development.

3. Impact on carbon credits from other sectors which is mostly accrued the benefits from Govt.

It will also be critical to understand how carbon credits are handled when they are generated from other sectors like forestry, waste management, agriculture, and transport sectors. On bare reading, the bill limits the energy conservation scope to renewable energy, energy efficiency sectors, steel, cement, and manufacturing industries with the addition of large building complexes. The same sectoral limitations can also be assumed for the carbon market. In the absence of any framework for other sectors where Govt has provided investment or support, it’s likely to some extent that these sectors will be subjected to the same test of the export ban in the near future, considering India’s updated NDC targets a reduction of emissions intensity of GDP by 45 per cent by 2030, compared to 2005 levels. Mostly waste management, forestry, and energy conservation initiatives will possibly need to be relooked into. It can be further evaluated over the next few months as to how corresponding adjustments as per Article 6 will be managed. Then it may be determined how and under what provisions these different industries will be accommodated within the carbon market.

4. Fungibility of carbon credits in the global arena.

The definition of carbon credit in the context of India needs attention. As per the bill, “carbon credit certificate” means the certificate issued by the Central Government or any agency authorised by it under section 14AA. With the emergence of many voluntary carbon market standards and participants and the overnight appearance of new players declaring a new standard/platform/registry, it will be critical to redraw the eligibility criteria for carbon credit certificates to make them fungible.

The carbon market globally has drawn flak due to credibility issues despite its novel intention, and thus the foundation of India’s carbon market has to be based on credible carbon credits. Considering that Article 6.4 is likely to be the catalyst for launching the carbon market under the Paris Agreement and that many of the CDM components may be preferred during this transition, the Indian government may prefer the carbon market framework that can closely adhere to the safest pathway in following the multilateral framework and Article 6.4 guidelines.

5. Carbon financing of projects with ground-breaking climate solutions.

Many of the sector players are working on ground-breaking climate solutions, where large investments are needed through carbon financing. Their mitigation measures are not part of the NDC, and even the government’s commitment and involvement are minimal or non-existence. It appears that the export ban of carbon credits does not intend for these sectors, as it could damage India’s reputation as a promising market for the commercialisation of high-quality carbon credits and deter investors from looking at the country. The government should make an effort to offer greater clarity to the qualitative and impact carbon investment sectors, where billions of dollars have been committed despite the lack of government incentives. Today, there is a greater demand for community-led and nature-based solutions from the private sector and communities with investment from impact funds that aim to reduce an enormous amount of greenhouse gas emissions. Many of these sectors –like those dealing with cookstoves and soil carbon in agriculture- are developing at an unprecedented pace by many of the next-age companies like Core CarbonX Sols Pvt Ltd, transforming the very nature of rural life and ecosystems.

Carbon credits categories that may evolve in India

After evaluating the existing circumstances, India may have three types of carbon credits: Category A) Part of the Energy Conservation Bill (RE and energy efficiency), the bulk of which will lose additional income if the export prohibition is implemented (but it will not have much impact on project portfolios considering they never intended to have the carbon credits), Category B) The majority of other sectors that are completely or partially subsidised or incentivised by the government, comparable to category (A), will be measured under the corresponding adjustment policy framework following COP 27. Finally, Category C) Projects that are generating pure carbon credits will not have an immediate impact on investment because of the export ban. These projects are happening only because of the associated carbon credits. Take the example of the cookstove billion-dollar investments that are being planned, and this will continue to flow.

Conclusion

From our perspective, the context of the Hon. Minister’s remarks on the export ban on carbon credits appear to have more to do with issues related to NDC and the corresponding adjustment. Although the present bill doesn’t restrict the export of carbon credits, India is already looking forward to establishing a comprehensive and consistent regulatory framework for safeguarding its commitment to NDC by limiting the export of certain credits.

Moreover, India needs a supportive policy framework applicable to the sectors in which there is limited government participation and engagement. This would assist in the flow of significant climate finance to reduce greenhouse gas emissions from these sectors and ultimately contribute to climate action in the country. In addition, we shouldn’t bundle the carbon credits each sector generates/receives into a single category. Lastly, considering the relatively limited number of domestic participants who would offset their carbon emissions, the demand for high-quality carbon credits is rather low in India and the future success of India’s domestic carbon market demand creation among the domestic players.