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What Exactly Are Carbon Markets And How Do They Function?

Context

  • The Indian Parliament recently passed the Energy Conservation (Amendment) Bill, 2022, rejecting the Opposition’s demand that it be referred to a parliamentary committee for review due to members’ concerns about carbon markets.
  • The Bill amends the Energy Conservation Act, 2001, to empower the government to establish carbon markets in India and specify a carbon credit trading scheme.
  • The article attempts to define carbon markets, highlights their various types, and discusses the challenges that carbon markets face.

Relevance

GS Paper – 3: Conservation, Groupings & Agreements Involving India and/or Affecting India’s Interests

Mains Question

Discuss global warming and its consequences for the global climate. Explain, in light of the Kyoto Protocol of 1997, the control measures to reduce the level of greenhouse gases that cause global warming. (150 Words)


What exactly are carbon markets?

  • They are simply a method of putting a price on carbon emissions by establishing trading systems in which carbon credits or permits can be bought and sold.
  • A carbon credit is a trading permit that equals one tonne of CO2 eliminated, reduced, or sequestered from the atmosphere, according to UN standards.
  • Carbon allowances or caps are set by countries or governments based on their emission reduction goals.

Carbon markets must be developed.

  • To limit global warming to 2°C (ideally 1.5°C), global greenhouse gas (GHG) emissions must be reduced by 25 to 50% over the next decade.
  • Nearly 170 countries have submitted their nationally determined contributions (NDCs) under the 2015 Paris Agreement, which must be updated every five years.
    • NDCs are climate commitments made by countries to achieve net-zero emissions. India, for example, is developing a long-term strategy to achieve its goal of net zero emissions by 2070.
    • Many countries are turning to carbon markets as a mitigation tool to meet their NDCs, as the Paris Agreement (Article 6) requires countries to use international carbon markets to meet their NDCs.
  • Previously, developing countries, particularly India, China, and Brazil, benefited significantly from a similar carbon market established in 1997 as part of the Kyoto Protocol’s Clean Development Mechanism (CDM).
    • For example, India has registered 1,703 CDM projects, the second most in the world.
    • CDM allowed a country with a Kyoto Protocol emission-reduction commitment (Annex B Party) to implement emission-reduction projects in developing countries.
    • However, the 2015 Paris Agreement altered the global scenario by requiring developing countries to set emission reduction targets.

Carbon market types

  • Compliance markets: These are established by policies at the national, regional, and/or international levels, are officially regulated, and mostly operate under the ‘cap-and-trade’ principle.
    • Governments issue annual allowances or permits to entities in this sector based on the amount of emissions they can produce.
    • Companies emitting more than the capped amount must purchase additional licences, either through official auctions or from companies emitting less than the maximum.
    • Carbon trading can be used by businesses to determine whether it is more cost-effective to use renewable energy technologies or to purchase additional credits.
    • The EU has the most popular compliance markets, and China will launch the world’s largest emission trading system (ETS) in 2021.
  • Voluntary markets: o It refers to the voluntary issuance, purchase, and sale of carbon credits by emitters such as corporations, private individuals, and others in order to offset the emission of one tonne of CO2 or equivalent greenhouse gases.
    • In a voluntary market, a corporation compensates for unavoidable GHG emissions by purchasing carbon credits from a project that reduces, removes, captures, or avoids emissions.
    • Climate projects are listed by traders and online registries for the purpose of purchasing certified credits and are verified by private firms in accordance with popular standards.
    • In the aviation industry, for example, airlines may purchase carbon credits to offset the carbon footprints of the flights they operate.

The Importance of Carbon Markets

  • These markets may encourage people to use less energy and switch to cleaner fuels.
  • Government-regulated trading schemes may prompt companies to innovate, invest, and adopt cost-effective low-carbon technologies because they provide a clear trajectory indicating how emission limits would be tightened and allowances made less available.
  • According to the World Bank, trading in carbon credits could cut the cost of implementing NDCs by more than half – up to $250 billion by 2030.

Carbon Market Difficulties

  • Double counting of GHG reductions, as well as the quality and authenticity of climate projects that generate credits due to insufficient market transparency.
  • There are also concerns about greenwashing, which occurs when companies buy credits to offset their carbon footprints rather than reducing their overall emissions or investing in clean technologies.
  • Green washing is the practise of making false claims to mislead consumers into believing that a company’s products are more environmentally friendly.
  • The IMF warns that including high-emissions sectors in carbon trading schemes may increase net emissions.

Concerns about the Energy Conservation (Amendment) Act of 2022

  • There is no mention of a market regulator for carbon credit trading in the bill.
  • Unlike in other jurisdictions such as the United States, the United Kingdom, and Switzerland, carbon market schemes in India have been proposed by the power ministry.
  • The bill does not specify whether carbon credit certificates will be traded using cap-and-trade schemes or another method.
  • In India, two types of tradable certificates are already available: Renewable Energy Certificates (RECs) and Energy Savings Certificates (ESCs).
    • The bill does not specify whether these certificates will be interchangeable with carbon credit certificates and tradable for the purpose of reducing carbon emissions.

Way ahead of schedule

  • The UNDP emphasises that for carbon markets to succeed, emission reductions and removals must be genuine and consistent with the country’s NDCs.
  • It states that the institutional and financial infrastructure for carbon market transactions must be transparent.

Conclusion

  • According to a UNDP report from 2022, 83% of NDCs submitted by countries mention their intention to use international market mechanisms to reduce GHG emissions.
  • To improve climate commitments by carbon markets, comprehensive policy formulation and robust implementation are required at the national-regional-international levels.

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