11 January 2024

Decarbonizing MSMEs Through The Indian Carbon Market: A Comprehensive Exploration

King, Stubb & Kasiva


King Stubb & Kasiva (KSK) - Advocates & Attorneys is a full-service law firm in India that has been operating since 2005 based in Delhi, Mumbai, Bengaluru, Chennai, Hyderabad, Kochi, & Italy with 120+ professionals. We specialise in M&A, litigation, arbitration, employment, labour, banking, finance, e-commerce, and emerging technology practices.
Micro, Small, and Medium Enterprises (MSMEs) are the lifeblood of India's industrial landscape, contributing around 29% to the nation's GDP and employing over 110 million people.
India Energy and Natural Resources
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Micro, Small, and Medium Enterprises (MSMEs) are the lifeblood of India's industrial landscape, contributing around 29% to the nation's GDP and employing over 110 million people (Ministry of Micro, Small & Medium Enterprises Annual Report, 2019-20). As India strides towards sustainable development, the decarbonization of MSMEs takes centre stage. This edition of our newsletter explores the dynamic interplay between MSMEs and the evolving Indian Carbon Market, shedding light on the intricacies of energy efficiency goals, existing schemes, and the potential impact of the carbon market on MSMEs.

MSMEs in India: A Statistical Overview

Understanding the significance of MSMEs necessitates a statistical lens. As per the Annual Report (2019-20) from the Ministry of Micro, Small & Medium Enterprises, MSMEs make up approximately 29% of India's GDP and provide employment to more than 110 million individuals. The significance of their contribution to fostering innovation, creating jobs, and supporting economic development cannot be emphasized enough.

Energy Efficiency: A Strategic Imperative for MSMEs

MSMEs, while vital to economic growth, are often energy-intensive. Their contribution to energy consumption and emissions is substantial. The need for sustainable practices is underscored by the fact that the industrial sector, including MSMEs, accounts for approximately 40% of India's total energy consumption (CEA General Review 2018).

The PAT scheme, introduced under the National Mission for Enhanced Energy Efficiency (NMEEE), serves as a linchpin in steering MSMEs toward sustainable energy practices. The scheme operates on a sectoral approach, with energy-intensive sectors like MSMEs falling under the purview.

Perform, Achieve, and Trade (PAT) Scheme: A Deep Dive

The PAT scheme, operates on a 'market-based mechanism,' promoting a paradigm shift in the way industries approach energy consumption and emissions. The scheme categorizes energy-intensive sectors into Designated Consumers (DCs) and imposes specific energy reduction targets on them.

Operational Framework of PAT Scheme

  1. Designated Consumers (DCs): Industries identified as significant energy consumers fall under the ambit of DCs. These include Thermal Power Plants, Cement, Fertilizer, and other energy-intensive sectors.
  2. Energy Reduction Targets: Each DC is allocated a specific energy reduction target, usually set as a percentage of their baseline energy consumption. This baseline is determined based on historical data.
  3. PAT Cycle: The scheme operates in cycles, each spanning three years. DCs must achieve their energy reduction targets within the stipulated cycle.
  4. Energy Saving Certificates (ESCerts): DCs that surpass their targets earn ESCerts, tradable instruments signifying the achieved energy savings.
  5. Trading Mechanism: DCs falling short of their targets must purchase ESCerts from those exceeding their goals, creating a market-driven mechanism for energy efficiency.

Benefits and Challenges of PAT Scheme

The PAT scheme holds several advantages. It provides a flexible approach, allowing DCs to choose the most cost-effective measures for achieving energy efficiency. It also stimulates innovation and investment in clean technologies. However, challenges persist, primarily relating to the accurate determination of baseline data and the need for stringent monitoring and enforcement mechanisms.

Sectoral Impact

Data from the Bureau of Energy Efficiency (BEE) indicates that during the 2014-15 to 2016-17 PAT Cycle I, the covered sectors collectively saved 8.67 million tons of oil equivalent (Mtoe), surpassing the targeted 6.686 Mtoe. These sectors included MSMEs engaged in industries like textiles, brick making, and chemicals.

State-wise Impact and Disparities

The effectiveness of the PAT scheme varies across states. For instance, Gujarat and Maharashtra reported significant energy savings, with Gujarat alone contributing to 24% of the national savings during PAT Cycle I. However, other states lag, revealing disparities in the adoption of energy-efficient practices.

Data from the State Energy Efficiency Index shows that states like Kerala and Odisha have demonstrated proactive initiatives, achieving the maximum score of 5. Conversely, states like Haryana and Punjab, while excelling in other sectors, face challenges in cross-sectoral indicators related to energy efficiency.

Emission Trading System (ETS): A Catalyst for MSMEs

Parallel to the PAT scheme, the Emission Trading System (ETS) introduces a market-based approach to carbon emissions reduction. This system operates on the principles of 'cap and trade,' where a cap is set on the total allowable emissions, and entities can trade emission allowances. The ETS is a significant stride in India's commitment to the Paris Agreement, providing a structured platform for MSMEs to participate in carbon reduction initiatives.

ETS Mechanism and MSME Participation

  1. Cap Setting: The government sets a cap on total emissions, ensuring an overall reduction in carbon footprint. This cap declines over successive periods, driving continual emission reductions.
  2. Allocation of Emission Allowances: Industries receive allowances corresponding to their emissions. Those exceeding their allocation must purchase additional allowances, creating financial incentives for emission reduction.
  3. Market Dynamics: A vibrant carbon market emerges as entities trade allowances. MSMEs can actively participate, either by reducing emissions and selling excess allowances or purchasing allowances to comply with set limits.

Quantifying the Potential for MSMEs

India's commitment to reducing emissions intensity by 33-35% by 2030 (compared to 2005 levels) aligns with the goals of the Paris Agreement. MSMEs, through participation in ETS, can significantly contribute to achieving these targets.

According to the Power Ministry's 'Power for All' initiative, the implementation of ETS could lead to a reduction of 563 million tons of CO2 emissions, an amount equivalent to powering 89 million homes for a year. This substantial impact underscores the transformative potential of MSMEs in the carbon market.

Challenges and Opportunities for MSMEs in ETS

While ETS introduces a progressive mechanism for MSMEs to engage in emissions reduction, challenges such as the establishment of accurate baselines and monitoring mechanisms persist. However, opportunities arise in the form of financial incentives, access to carbon finance, and enhanced environmental credibility.

The Voluntary Carbon Market (VCM) Landscape:

The VCM, a formidable lever, swiftly mobilizes billions to finance projects protecting nature, reducing emissions, and removing carbon—a crucial financing tool for scaling up quickly. Its role complements carbon abatement, supporting communities and ecosystems, and empowering corporations to deliver climate action for net-zero ambitions. Different in-house capabilities are required for corporations to deliver their carbon markets ambition, and several stakeholders, including regulators, standard setters, and corporations, needs to work together to address obstacles in the VCM and promote engagement.

To comprehend the intricate dynamics of the Voluntary Carbon Market fully, it is crucial to distinguish between two fundamental concepts: carbon credits and carbon offsets. Carbon Credits serve as a quantifiable unit representing the reduction or elimination of one metric ton of carbon dioxide equivalent (CO2e) emissions. These credits, obtained through projects that reduce emissions, transform into tradable commodities, thereby fostering a market-driven approach to sustainability.

Conversely, Carbon Offsets operate on the principle of compensatory actions to counterbalance emissions. This involves investing in projects that absorb or reduce emissions elsewhere. While both credits and offsets contribute to the overall goal of mitigating climate change, their mechanisms and applications differ significantly within the carbon market framework.

Carbon credits and offsets are generated through various mechanisms, each with its own unique set of criteria and procedures.

Project-based mechanisms lie at the heart of credit generation. Entities develop projects that demonstrably reduce or remove greenhouse gas emissions, such as installing renewable energy systems or implementing sustainable forest management practices. Stringent methodologies and rigorous monitoring protocols ensure the accuracy and validity of emission reductions achieved by these projects. Verification by independent third-party bodies further strengthens the integrity of the generated credits.

Performance-based mechanisms, often employed within regulatory frameworks, operate under a different paradigm. Regulated entities, such as industries or power plants, are assigned emission reduction targets. Those exceeding their targets generate allowances, essentially permits to emit, while those falling short must purchase allowances from others to comply. This system incentivizes innovation and facilitates cost-effective emission reduction strategies within the regulated sector.

Trading Mechanisms: Once generated, carbon credits and offsets enter a vibrant global market. Spot markets offer immediate purchase and sale of credits, facilitating dynamic price discovery and enabling immediate emission reduction impact. Alternatively, forward contracts allow for long-term agreements between buyers and sellers, providing stability and predictable pricing for larger transactions.

Regulated exchanges and over-the-counter (OTC) platforms facilitate these transactions. Brokers and intermediaries play a crucial role in connecting buyers and sellers, ensuring efficient market operations and transparency.

Ensuring Environmental Integrity: The success of carbon markets hinges on robust verification and monitoring protocols. Independent and accredited certification bodies oversee project development and emission reduction calculations, ensuring the legitimacy and environmental integrity of generated credits and offsets.

Addressing potential challenges like double counting and leakage is critical. Double counting occurs when the same emission reduction is counted twice, inflating the perceived impact. Leakage refers to the displacement of emissions from one location to another, negating the intended environmental benefits.

Crucial Dynamics in 2024: The VCM plays a pivotal role as a transition finance option, rapidly connecting private capital to high-impact projects that mobilize funds for nature protection, emissions reduction, and carbon removal. Amid a critical need to curtail emissions, 2021's climate finance only met 20% of the $4.3 trillion required by 2030. Corporations seize immediate climate action opportunities by utilizing the VCM, positioning for net-zero ambitions through baseline emissions, target setting, and consideration of co-benefits. On a global scale, Article 6 of the Paris Agreement introduces carbon trading mechanisms for countries. Despite current policy limitations, collaborative efforts involving diverse in-house capabilities can help address obstacles and foster engagements. Corporations aiming for a positive impact can strategically navigate VCM's stages, transparently communicating outcomes to other stakeholders and contribute towards a sustainable, decarbonized future.

Clean Development Mechanism (CDM): A Global Perspective

The Clean Development Mechanism, an integral part of the Kyoto Protocol, allows developed countries to invest in emissions reduction projects in developing nations. MSMEs, by undertaking Clean Development Mechanism projects, can not only contribute to global emissions reduction but also avail financial benefits.

MSMEs and CDM Projects

  1. Types of Projects: MSMEs can engage in various CDM projects, including renewable energy installations, energy efficiency enhancements, and sustainable waste management.
  2. Financial Incentives: By participating in CDM projects, MSMEs can earn Certified Emission Reductions (CERs), which can be sold to developed nations seeking to meet their emission reduction targets.
  1. Financial Incentives: MSMEs engaging in CDM projects not only contribute to global emissions reduction but also gain financial incentives. The Haryana government's MoU with NIT Kurukshetra for R&D in energy efficiency exemplifies the proactive steps states are taking.
  2. Global Acknowledgment for Local Initiatives: States like Kerala and Andhra Pradesh, with independent State Designated Agencies (SDAs) promoting energy efficiency, showcase how local initiatives garner global acknowledgment. MSMEs, by aligning with such state-driven initiatives, can position themselves on the international stage as champions of sustainability.

International Certifications: Within the realm of international carbon markets, certifications play a pivotal role in establishing the credibility and legitimacy of emission reduction projects. The Gold Standard, administered by the EKI, stands as a prominent certification ensuring that carbon reduction projects not only contribute to mitigating climate change but also adhere to stringent social and environmental criteria.

As MSMEs venture into the Indian Carbon Market, the pursuit of certifications such as the Gold Standard becomes a strategic imperative. Achieving the Gold Standard certification signifies not only a commitment to environmental sustainability but also an endorsement of ethical business practices, providing MSMEs with a competitive edge in the evolving carbon landscape.

Addressing the Loss & Damage Fund Challenge: A Call for Holistic Participation

The global community should establish a Loss and Damage fund modelled after the International Monetary Fund's Reserve Tranche, with the possibility of additional Special Drawing Rights rounds if necessary. This initiative should be expanded to effectively tackle compensation for Loss and Damage in Low-Income Countries and Small Island Developing States. While mechanisms like the Loss & Damage Fund aim to support climate-vulnerable countries, it's imperative for MSMEs to recognize their role in bridging the financial gap. The data from the Ministry of Statistics and Programme Implementation's Energy Statistics 2016 reveals that India's industrial sector's energy intensity increased by 1.3% from 2004-05 to 2014-15. This underscores the urgency for sustainable practices.

Conclusion: A Roadmap for MSMEs in the Carbon Market

As MSMEs embark on their decarbonization journey within the Indian Carbon Market, the synthesis of data, policies, and global perspectives becomes paramount. State-wise disparities, sectoral impacts of the PAT scheme, and the transformative potential of ETS, VCM & CDM projects collectively paint a comprehensive picture.

The roadmap for MSMEs involves not only complying with regulatory mechanisms but actively engaging in sustainable practices. The data-driven insights provided by various indices and reports serve as navigational tools, guiding MSMEs to make informed decisions in their pursuit of sustainability.

In conclusion, the amalgamation of data-driven strategies, state-driven initiatives, and global participation positions MSMEs as not just contributors but leaders in India's ambitious journey toward a low-carbon economy. As they navigate the evolving landscape of the Indian Carbon Market, MSMEs have the opportunity not only to enhance their operational efficiency but to carve a niche as pioneers in sustainable and responsible business practices.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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