Indian Council of World Affairs

INTRODUCTION 

India is the second-largest producer of steel in the world, which is also essential to the Indian economy as it accounts for almost 2% of the GDP and employs around two million people;[i] 30% of our iron and steel exports are to the EU.[ii] India is also the world’s third-largest exporter of aluminium, with more than 20% of the exports going to the EU.[iii] Under the Carbon Border Adjustment Mechanism (CBAM) been implemented by the EU, India’s steel and aluminium industries are going to be impacted the most as CBAM adds a 13% tariff on steel and 6% on aluminium, resulting in a loss of revenue of $1–1.7 billion.[iv]Since iron, steel and aluminiumproduction are highly energy intensive, the energy for which is sourced from coal, the carbon intensity of these products becomes higher compared to that of the EU and other exporting countries. This will result in a decrease in export competitiveness, which would lead to a loss of income for the Indian industries as they will have to pay a higher price under the CBAM.[v]

To maintain the competitiveness of Indian industries and not lose revenue through unilateral measures such as CBAM, India has started the implementation of a national Emission Trading System (ETS), which will price carbon. This paper seeks to explain the basic concepts of carbon pricing and border adjustment mechanisms, the current state of the carbon market in India, lessons to be learned from ETSs around the world, and finally, the global context of India’s ETS. 

WHY ARE BORDER ADJUSTMENT MECHANISMS PLACED? 

Carbon pricing mechanisms are globally used to reduce emissions in the most economically efficient way possible. This helps in capturing the external costs of greenhouse gas emissions which would essentially lead industries and individuals to switch from high-carbon-intensity goods to low-carbon alternatives.[vi]

To avoid paying carbon price in their home country, many industries shift their production to countries with laxer climate policies. This phenomenon is called “carbon leakage,” which is the logic behind Border Adjustment Mechanisms. The Carbon Border Adjustment Mechanism (CBAM), as part of Europe’s Green Deal and “Fit for 55” agenda, ensures that “imported products are subject to a regulatory system that applies carbon costs equivalent to those borne under the EU ETS, resulting in a carbon price that is equivalent for imports and domestic products.”[vii]This means both domestic products and imported goods will be subject to the same carbon price.It will help protect EU’s domestic industries and also encourage other countries to adopt decarbonisation measures. 

HOW TO DEAL WITH BORDER ADJUSTMENT MECHANISMS? 

CBAM regulation states that countries will be “allowed to claim a reduction in the number of CBAM certificates to be surrendered corresponding to the carbon price already effectively paid in the country of origin for the declared embedded emissions.” This means that if the industries are already paying a price on carbon in their home country during production, they will be partially or fully exempt from CBAM depending on the price of carbon prevailing in the home country relative to that of the EU ETS. Therefore, adopting carbon pricing mechanisms in India would help achieve two targets under one policy: avoiding revenue loss due to CBAM and achieving our Nationally Determined Contributions (NDCs) through mitigation of greenhouse gases. 

Carbon pricing mechanisms can be of two types: a carbon tax or an emission trading system. A carbon tax is a direct price on greenhouse gas emissions based on the carbon content of fossil fuels.[viii] On the other hand, an ETS works like a cap-and-trade system where a cap is placed on the total level of greenhouse gas emissions permissible and based on this cap,emission allowances or permits[ix] are distributed to different industries.Permits or allowances are individual limits (like certificates) given to industries which defines how much they can emit. If an industry emits less than the allowances they have, the remainder of these allowances turn into credits which can be traded. If an industry emits more than what is allowed, they can buy these credits to offset their excess emissions. The emissions are lowered by lowering the cap each year, meaning the number of allowances decreases, which incentivises industries to invest in decarbonisation. Through this market mechanism, a price of carbon will emerge, reflecting the true social cost.[x] India has started working on a cap-and-trade ETS, which will be in effect in 2026 and create the National Carbon Market (NCM). 

CURRENT STATE OF THE CARBON MARKET 

The Energy Conservation (Amendment) Act 2022 enables the government to implement a Carbon Credit Trading Scheme (CCTS) in India. The responsibility for creating this scheme has been given to the Bureau of Energy Efficiency. India already hosts two market mechanisms to lower its emission reductions, which are the PAT scheme and the REC scheme.[xi] Under the Perform, Achieve and Trade (PAT) scheme, targets are set for energy consumption for different industries. Accordingly, Energy Saving Certificates (ESCerts) are given to industries that overachieve their prescribed targets, which can then be traded to industries that cannot achieve their targets. Similarly, the Renewable Energy Certificate (REC) scheme puts an obligation on industries to have a certain percentage of their energy consumption as renewable energy. Those exceeding the requirements can trade the RECs with those not fulfilling them.[xii] The CCTS builds on these two established frameworks and broadens their scope by creating a single unified carbon market. The carbon market is set to be implemented in a phase-wise manner, the details of which are mentioned in the policy draft from the Bureau of Energy Efficiency (BEE). 

In India, the rollout of the CCTS is aligned with the CBAM timeframes. The transition period of CBAM, which requires exporters to report their emissions, coincides with phase 1 of the CCTS, where different markets are merged into one single carbon market. As the CBAM goes into effect by 2026, the NCM starts its operation at the same time, covering the same industries as those included under the CBAM. 2034 is when CBAM goes into full effect, covering all exports to the EU, which is the same timeframe by which the NCM becomes mandatory, covering a large number of sectors.[xiii]

LESSONS FROM GLOBAL ETSs 

Implementing an emission trading system is an administratively challenging task, as reflected by the experiences of various countries that have established it before. Lessons from the experiences can help India avoid mistakes and achieve a carbon price that considers all the social costs of carbon. 

Free allowances or auctions 

An ETS puts a cap on the total level of emissions, and the allowances for industries are distributed accordingly. These allowances can be given out for free or through an auction system. Most ETSs around the world started with the free allocation of allowances and gradually shifted to selling these allowances via auctions. This not only helps to minimise the compliance burden but also allows for more support from industries for the policy and provides time for the companies to adjust and make modifications to their costs of production. The EU’s goal to phase out free allowances and auction all allowances aligns with its implementation of CBAM.[xiv] This is because auctioning allowances means the cost of production for industries in the EU would increase since industries have to buy allowances, which makes goods produced in the EU expensive. Hence, to protect their domestic industry and maintain competitiveness with exports, the EU plans to roll out the CBAM. 

Oversupply of credits 

If allowances are supplied in excess, they would lead to an oversupply of carbon credits, which would bring the price of carbon down, negatively affecting the mitigation of emissions. The PAT scheme and the REC scheme in India suffered from a similar problem with an excess supply of trading certificates.[xv] The EU ETS until 2019 faced the same problem, where carbon prices were always at low levels due to an oversupply of carbon allowances.[xvi] The EU introduced the Market Stability Reserve (MSR)[xvii] in 2019, through which it could adjust the supply of allowances in the market.[xviii] Similar to the MSR, the Regional Greenhouse Gas Initiative (RGGI), a subnational emission trading scheme in the United States, has two mechanisms for maintaining stability in the market: cost containment reserves (which inject allowances if prices are too high) and emissions containment reserves (which remove allowances if prices are too low).[xix]Similar to the MSR, the National Carbon Market (NCM) in India is also proposed to have a stabilisation fund of $100 million, which can buy excess allowances in case the price drops too low.[xx] Therefore, an important goal would be to ensure that there are correct number of allowances in the market for the appropriate price. 

Therefore, with prior experience of market mechanisms like the PAT and the REC scheme, Bureau of Energy Efficiency (BEE) can use a decade of institutional experience in handling the PAT scheme, and lessons from other countries should ensure a smooth transition and minimise problems in the new CCTS in India. 

GLOBAL CONTEXT OF INDIA’S ETS 

A national ETS will not just help maintain export competitiveness with other countries but also help incentivise industries to invest in carbon reduction technologies. Since emitting less provides an industry with credit to trade, it might work as an additional source of profit. While this accounts for domestic investment, there is also scope for foreign investment through the trading of carbon credits with countries. Though the BEE draft states that the priority is to use funds to first build a domestic market to support India’s Nationally Determined Contribution (NDC) targets, trading of carbon credits will be done if there is a transfer of cutting-edge technology or sufficient foreign investment in building carbon storage and mitigation techniques.[xxi] The government has come up with three categories of activities under which, if a technology transfer or investment is made, credits can be eligible for trading. These activities include greenhouse gas mitigation, alternative materials like green ammonia and carbon removal activities.[xxii] In this respect, India is engaging bilaterally with Germany and Japan to support green hydrogen production in India through the transfer of technology and investment through the trading of carbon credits.[xxiii]

CONCLUSION

Carbon pricing mechanisms are expanding globally as countries try to reduce their emissions in an efficient way without impacting their economic growth. Therefore, to protect their domestic industries, countries will follow suit and come up with their own border adjustment mechanisms. The UK has already revealed that they will be rolling out their version of CBAM by 2027, while Canada and Japan are working out their own carbon border taxes.[xxiv] In this light, having a national carbon pricing mechanism of one’s own will be really important, as it will help India to economically align with the largest economies in the world and maintain industries that will be environmentally competitive with other nations. 

Therefore, harmony with global ETS regulations and conformity to international protocols about monitoring, reporting and verification standards will help legitimise the Indian emission trading system and prove to be an equivalent measure for waivers against carbon border mechanisms in the future. Once the national carbon market is fully implemented, the Indian government can then implement a border adjustment mechanism of its own.

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*Divyajyoti Swain, Research Intern, Indian Council of World Affairs, New Delhi
Disclaimer: Views expressed are personal.

Endnotes

[i] “Export Attractiveness of India’s Steel Sector: IBEF.” India Brand Equity Foundation, June 9, 2022. https://www.ibef.org/blogs/export-attractiveness-of-india-s-steel-sector.

[ii] Narayan, Subhash, and Saurav Anand. “India’s Steel Exports to EU to Come under Pressure on CBAM Framework: ICRA.” LiveMint, June 23, 2023. https://www.livemint.com/industry/indias-steel-exports-to-eu-to-come-under-pressure-on-cbam-framework-icra-11687517299420.html.

[iii] “CBAM Dent Awaits Aluminium Makers.” CRISIL, June 2023. https://www.crisil.com/content/dam/crisil/our-analysis/views-and-commentaries/sectorvector/2023/06/cbam-dent-awaits-aluminium-makers.pdf.

[iv] “The Carbon Border Adjustment Mechanism: EU’s Climate Trojan Horse to Obstruct Imports.” GTRI, March 2023. https://gtri.co.in/gtriFlagshipRep3.pdf.

[v] “Steel Climate Impact - an International Benchmarking of Energy and CO2 Intensities.” Global Efficiency Intelligence, April 2022. https://www.globalefficiencyintel.com/steel-climate-impact-international-benchmarking-energy-co2-intensities.

[vi] “What Is Carbon Pricing?” Carbon Pricing Dashboard, August 18, 2022. https://carbonpricingdashboard.worldbank.org/what-carbon-pricing.

[vii] “REGULATION (EU) 2023/956 OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL of 10 May 2023: Establishing a Carbon Border Adjustment Mechanism.” Official Journal of the European Union, May 16, 2023. https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32023R0956.

[viii] “Carbon Tax Basics.” Center for Climate and Energy Solutions, May 1, 2024. https://www.c2es.org/content/carbon-tax-basics/.

[ix]In our context, the terms “allowances” and “permits” can be used interchangeably.

[x] “How Do Emissions Trading Systems Work?” Grantham Research Institute on climate change and the environment, December 11, 2023. https://www.lse.ac.uk/granthaminstitute/explainers/how-do-emissions-trading-systems-work/.

[xi]Oxford Institute for Energy Studies (University of Oxford). “Building the Indian Carbon Market: A Work in Progress.” Oxford Institute for Energy Studies, 2023. http://www.jstor.org/stable/resrep49373.

[xii]Bureau of Energy Efficiency (2022), Policy Paper on Indian Carbon Market (ICM), Government of India. https://cer.iitk.ac.in/odf_assets/upload_files/blog/Draft_Carbon_Market_Policy_DocumentFor_Stakeholder_Consultation.pdf

[xiii] Jaishankar, Dhruva. “Canceling Carbon: The Global Context of India’s New National Carbon Market.” ORF America, March 21, 2024. https://orfamerica.org/newresearch/cancelling-carbon-global-india.

[xiv] “Lessons for Structuring India’s Carbon Market to Support a Cost-Efficient Energy Transition .” Center on Global Energy Policy at Columbia University SIPA | CGEP, May 13, 2024. https://www.energypolicy.columbia.edu/publications/lessons-for-structuring-indias-carbon-market-to-support-a-cost-efficient-energy-transition/.

[xv]Oxford Institute for Energy Studies (University of Oxford). “Building the Indian Carbon Market: A Work in Progress.” Oxford Institute for Energy Studies, 2023. http://www.jstor.org/stable/resrep49373.

[xvi] Ibid.

[xvii]The Market Stability Reserve is a mechanism which helps balance supply and demand of allowances and stabilize supply in order to ensure efficiency of the EU emissions trading system. It works by absorbing excess supply of allowances which helps price from not falling by a big margin.

[xviii] “The Market Stability Reserve in the EU Emissions Trading System: A Critical Review.” Grantham Research Institute on climate change and the environment, March 5, 2024. https://www.lse.ac.uk/granthaminstitute/publication/the-market-stability-reserve-in-the-eu-emissions-trading-system-a-critical-review/.

[xix] “Emissions Trading Systems in India and around the World.” Economic Law Practice, June 2023. https://elplaw.in/wp-content/uploads/2023/06/Restructured-Emissions-Trading-Systems-in-India-and-Around-the-World.pdf.

[xx] “Exclusive: India to Bolster Carbon Trading Market with Stabilisation Fund | Reuters.” Reuters, December 22, 2022. https://www.reuters.com/business/sustainable-business/india-bolster-carbon-trading-market-with-stabilisation-fund-2022-12-21/.

[xxi] BEE. “Policy Paper on Indian Carbon Market.” Ministry of Environment, Forest and Climate Change, October 2022. https://cer.iitk.ac.in/odf_assets/upload_files/blog/Draft_Carbon_Market_Policy_DocumentFor_Stakeholder_Consultation.pdf.

[xxii] “Activities Finalised to Be Considered for Trading of Carbon Credits under Article 6.2 Mechanism to Facilitate Transfer of Emerging Technologies and Mobilise International Finance in India.” Press Information Bureau, February 17, 2023. https://pib.gov.in/PressReleaseIframePage.aspx?PRID=1900216.

[xxiii] “Second Edition of Plant Engineering & Production Subworking Group Meeting under Indo-German Green Hydrogen Task Force.” Indo-German Energy Forum, 2023. https://www.energyforum.in/home/2023/20230320-gh2-taskforce-swg1-deliverables/.

[xxiv] “Factsheet: UK Carbon Border Adjustment Mechanism.” GOV.UK, December 18, 2023. https://www.gov.uk/government/consultations/addressing-carbon-leakage-risk-to-support-decarbonisation/outcome/factsheet-uk-carbon-border-adjustment-mechanism.