The previous note discussed the administrative apparatus related to India's Carbon Credit Trading Scheme, 2023 (the "CCTS," and the final version, the "Final CCTS"), as notified on June 28 by India's Power Ministry ("MoP") in consultation with the Bureau of Energy Efficiency ("BEE"), collectively representing the central government ("CG") in this regard. Given the wider ecosystem of integrated energy markets, in this note, we analyze the scheme as a whole – and especially in the context of global decarbonization initiatives, including in connection with past and present templates related to energy savings and trading mechanisms, both Indian and international.
The CCTS: Background
While the Energy Conservation Act, 2001 (the "EC Act") was first amended in 2010 (the "2010 Amendment") for the purpose of expanding upon the scope of the original legislation, a market-based regulatory framework – known as 'Perform, Achieve and Trade' ("PAT") – was established soon thereafter with the aim of reducing the specific energy consumption ("SEC") in energy-intensive industries.
As briefly described in the previous note, PAT involves the trading of certifications related to excess energy savings (such energy saving certificates, "ESCerts"). Thus, when a 'designated consumer' ("DC") overachieves its SEC targets in a given compliance year (such overachieving DC, a "DC 1"), ESCerts are issued to it for free, reflecting the difference between the CG-notified target and the actual SEC achieved by the DC 1. On the other hand, a DC that fails to reduce its SEC to the extent notified (such underachieving DC, a "DC 2") is required to purchase ESCerts from a DC 1 equivalent to the quantum of shortfall, failing which the DC 2 may face penalties under the EC Act.
The Final CCTS is somewhat similar to PAT in design. This is unsurprising since – as discussed later in the note – the BEE's recent proposals about structuring an Indian carbon credit trading framework have stemmed from its own past experience under PAT and the EC Act – especially after the 2010 Amendment. Further, given the lessons stemming from, and perceived shortcomings with respect to, PAT, the CCTS may eventually subsume excess ESCerts (along with other instruments) by converting them into carbon credit certificates ("CCCs," and such converted CCCs, "C-CCCs").
Meanwhile, PAT's design resembles a 'cap-and-trade' mechanism ("CAT"), somewhat like the EU's emissions trading scheme ("ETS") – the world's first. However, an ETS may also be designed as a 'baseline-and-credit' system ("BAC").
CAT and BAC
A CAT framework requires a fixed upper limit (i.e., a 'cap') on the volume of greenhouse gas ("GHG") emissions in one or more economic sectors. Tradable permits – where each allowance represents the right to emit a certain volume of emissions – are either auctioned or freely distributed. While PAT deals with trading in ESCerts, the state government of Gujarat signed a memorandum of understanding last year to implement a subnational CAT carbon market – India's first.
Meanwhile, under a BAC system, there is no fixed limit on emissions, but polluters can earn 'credits' by reducing their emissions beyond a 'baseline'. Such earned credits can then be sold to those that need or want them – whether in order to comply with applicable regulations, or to meet stakeholder demand in terms of managing/reducing their carbon footprint.
However, PAT differs from traditional CAT systems because it sets intensity-based energy targets. Among major emerging economies like India, the policy emphasis is on intensity (i.e., the volume of emissions per unit of gross domestic product ("GDP")) – rather than on an absolute cap. This altered stance stems from a concern that hard quantitative limits are likely to inhibit economic growth. While an absolute quantity-linked cap has the advantage of predictability with respect to emission levels, an intensity-based target allows such emissions to fluctuate with flux in economic development.
Intensity and EE
PAT differs from regular ETS models since it involves a framework based on energy-intensity ("EE") rather than on emissions itself. Thus, PAT is more of an EE trading system, rather than a plain vanilla ETS. For instance, ESCerts are not denominated in terms of GHG reductions – even while the latter remains the de facto trading unit of most carbon markets around the world.
In general, carbon pricing aims to curb GHG emissions by placing a fee on emissions and/or by offering incentives for emitting less. The price signal thus created is expected to shift consumption and investment patterns. While government-mandated carbon taxes or a traditional ETS are obvious manifestations of putting a price on carbon, PAT is an example of implicit pricing.
Such implicit carbon pricing strategies involve targets or obligations which must be met by surrendering a tradeable commodity at the end of a stipulated period, or by participants undertaking compliance measures within such period. Accordingly, these instruments can complement an ETS, or may prepare an evolving market for an eventual ETS rollout.
Indeed, other countries too have sought to integrate carbon pricing instruments with pre-existing trading systems based on targets and/or obligations related to EE (e.g., PAT) or the use of renewable energy ("RE"). In India, for example, the Electricity Act, 2003, as amended, requires certain categories of obligated entities (such as state-owned electricity distribution companies ("discoms")) to purchase a minimum percentage of their electricity from RE sources. This requirement is known as renewable purchase obligations ("RPO"). More specifically, when such obligated entities face procurement-related issues due to intermittent RE supply across states or on account of variations in quality, RE certificates ("RECs") may be used to meet RPOs. Thus, RECs are market-based tradeable instruments that represent the environmental attributes of RE.
CCMs and VCMs
The other way to distinguish between energy markets is through the prism of compliance. For instance, compliance carbon markets ("CCMs") consist of sovereign authorization and mandatory implementation. On the other hand, voluntary carbon markets ("VCMs") are driven by demand from those that aim to offset their GHG emissions – including on account of corporate 'net zero' commitments. Thus, for example, BAC schemes are often voluntary, allowing for the purchase and sale of carbon credits among corporate entities. Since VCMs function independently of CCMs, the credits issued in the former cannot be used to meet the legal and/or regulatory obligations imposed by the latter.
As described later in the note, it appears that, over the past couple of years, the BEE has intended to focus on developing VCMs first, before integrating India's compliance regime with global CCMs.
Compliance and Voluntary Mechanisms under the CCTS
As discussed in the previous note, the draft CCTS (the "Draft CCTS") released on March 27, 2023 had contemplated both a compliance and a voluntary regime. However, the Final CCTS mentions only a compliance mechanism.
Since specific targets and timelines need to be provided for separate industries under the compliance regime, it is expected that eventual CCC trading in this regard will take some time.
Although the Final CCTS makes no mention of a voluntary regime, pursuant to a gazette notification dated June 26, 2023, the Ministry of Environment, Forests and Climate Change ("MoEFCC") proposed the Draft Green Credit Programme Implementation Rules, 2023 ("Draft Green Credit Rules") – which seek to establish a domestic voluntary market mechanism called the 'Green Credit' program.
This Green Credit program is expected to encourage private sector industries, companies and other stakeholders to fulfill their respective obligations with the aim of generating green credits and pursuing acquisition activities.
The Green Credit Program
According to the Draft Green Credit Rules, green credits may arise from a range of sectors and entities. In essence, such green credits will be tradable outcomes and are intended to act as incentives. Further, green credits are proposed to be made available for trading on a domestic market platform.
An environmental activity that generates green credits may have climate co-benefits, such as reduction or removal of carbon emissions. An activity that generating green credits under the Green Credit program may also get carbon credits from the same activity under the carbon market.
BEE's Past Proposals
In March 2021, the BEE had issued a request for proposal in respect of developing a blueprint to design a voluntary EE market in India (the "RFP"). A year later, in a draft blueprint for stakeholder consultation ("Proposal 1"), the BEE proposed three phases towards the eventual adoption of a CAT system for India's proposed ICM.
Subsequently, in October 2022, the BEE conducted a stakeholder consultation to get inputs on a revised proposal ("Proposal 2") where the proposed three-phase transition in Proposal 1 was reduced to two phases.
Although the RFP stated that that the BEE was exploring the possibility of tapping into additional demand for ESCerts by linking PAT with international carbon market programs (with the hope that such linkages would support ESCert trading prices), it did admit that the actual surplus in ESCert supply would require the enhancement of corresponding demand under PAT itself. However, the BEE also acknowledged that in its current form, PAT left out nearly 50% of energy savings potential from industry (especially among micro, small, and medium enterprises (MSMEs)) and did not include residential households or other large energy users either (e.g., urban local bodies). Thus, in the RFP itself, the BEE expressed its intent of extending PAT to a VCM framework for the purpose of tapping into initiatives of non-state and sub-national actors (including companies, investors, financial institutions, municipal authorities, and states) under the auspices of the existing EC Act – albeit with modifications, such as those eventually witnessed in the 2022 Amendment.
In this regard, the RFP also referred to the untapped potential of carbon pricing, anticipating that a BEE-driven market could generate the necessary confidence necessary to overcome entry barriers – such as the lack of consistent and clearly defined price-setting benchmarks – for the purpose of encouraging new entrants to join a widened Indian VCM.
The BEE's Proposal 1 comprised three distinct phases.
The proposed first phase under Proposal 1 sought to increase VCM demand by opening it up to buyers other than DCs. Further, this phase was intended to include fungibility in the sense that ESCerts and RECs would be allowed to trade as carbon offsets alongside CCCs.
The BEE's reasons for championing fungibility at this stage by attracting voluntary buyers (and sellers, according to future requirement) appears to be based on past learning from PAT. While PAT did reduce emissions significantly in its first few cycles, a continued surplus in ESCerts supply has nevertheless plagued such market. Coupled with muted demand, this has led to sustained low prices. However, PAT is premised on the assumption that the price of ESCerts will incentivize DCs to focus on EE. Accordingly, current circumstances may eventually deter DCs from investing in technologies based on EE – unless the underlying demand-supply mismatch is addressed. Thus, given that several non-DC entities already have stated GHG reduction commitments, and for the purpose of generating extra demand for the surplus ESCerts issued under PAT, the first phase of Proposal 1 sought to provide non-DC entities and/or voluntary buyers/sellers with an opportunity to trade in ESCerts by tapping into the readily-available interest among private sector entities.
Further, voluntary commitments with respect to companies (including in India) are typically denominated and/or expressed in terms of reducing CO2 emissions – and not on improving EE. Thus, variation in the unit of trading may itself lead to compatibility issues. In that respect, the proposed fungibility associated with ESCerts was intended to lead to international participation, in conjunction with increased adoption of the underlying instrument.
Further, the BEE expected demand to stem from five principle sources: (i) voluntary buyers, (ii) existing DCs which are part of PAT, (iii) designated state agencies which may be permitted to participate in India's VCM, (iv) discoms with RPO obligations, and (v) the aviation sector as a whole – given global concerns about growing emissions from the airlines industry, as witnessed through schemes such as the Carbon Offsetting and Reduction Scheme for Aviation (CORSIA) developed by the International Civil Aviation Organization (ICAO), which requires airlines and other aircraft operators to offset growth in CO2 emissions.
The second phase under Proposal 1 aimed to increase the supply of carbon credits in the voluntary market by opening it up to sellers other than DCs. This may involve the registration and validation of emission reduction projects – which can subsequently issue emission reduction units or carbon credits.
In the third phase, the voluntary market was expected to evolve into a mandatory CAT system, in which DCs would be required to restrict their emissions within a pre-fixed cap.
In Proposal 2, the first two phases suggested in Proposal 1 were merged into one.
In effect, the Indian carbon market ("ICM") would comprise CCCs as a tradeable commodity, with each CCC equal to one tCO2e. Further, CCCs could be further be divided into C-CCCs, mandatory CCCs ("M-CCCs") and offset CCCs ("O-CCCs"). ESCerts, RECs, and surplus Clean Development Mechanism ("CDM") credits will be converted to carbon credits or offsets as C-CCCs.
Historically, the CDM has allowed emission-reduction projects in developing countries to earn certified emission reduction ("CER") credits. These CERs can be traded and sold, and in turn, may be used by industrialized countries to a meet a part of their emission reduction targets under the Kyoto Protocol.
Meanwhile, obligated entities under the ETS mechanism would generate and trade M-CCCs, and the O-CCCs would be generated as part of the offset scheme under the ICM.
The first transition phase (2023-25) under Proposal 2 was proposed to focus on the fungibility of ESCerts and RECs into offsets. Entities with surplus ESCerts and RECs may choose to convert them into C-CCCs. Based on criteria such as fuel mix and additionality, an entity-specific conversion factor was proposed to be stipulated for the purpose of converting surplus ESCerts into offsets.
Meanwhile, PAT was intended to remain in force in the first phase of Proposal 2. This phase would include the development of the offset market; guidelines related to monitoring, reporting, and verification (MRV); setting up a registry; and a comprehensive governance structure for both offset and compliance markets, in consultation with relevant stakeholders.
In the second phase of Proposal 2 (2026 onwards), a fully functional national ETS was proposed to be launched involving sectors and entities that were already part of PAT. Obligated entities would be provided with a GHG emission intensity target, and M-CCCs would be allocated accordingly. Based on performance in respect of EE, these entities could choose to abate or trade in emissions.
Given that detailed procedures with respect to the Final CCTS may be outlined over time, it is possible that such scheme details will subsequently capture BEE's earlier proposals – including in connection with a phased transition.
This insight/article is intended only as a general discussion of issues and is not intended for any solicitation of work. It should not be regarded as legal advice and no legal or business decision should be based on its content.