What are carbon markets and how do they operate?

Context

Recently passed Energy Conservation (Amendment) Bill, 2022 empowers the Government to establish carbon markets in India and specify a carbon credit trading scheme.

What are carbon markets?

To meet Nationally determined contributions (NDCs), one mitigation strategy is becoming popular with several countries— carbon markets.
Article 6 of the Paris Agreement provides for the use of international carbon markets by countries to fulfil their NDCs.
Carbon markets are essentially a tool for putting a price on carbon emissions— they establish trading systems where carbon credits or allowances can be bought and sold.
A carbon credit is a kind of tradable permit that, per United Nations standards, equals one tonne of carbon dioxide removed, reduced, or sequestered from the atmosphere.
These markets create incentives to reduce emissions or improve energy efficiency.

Sentiments of countries about carbon markets

About 83% of NDCs submitted by countries mention their intent to make use of international market mechanisms to reduce greenhouse gas emissions.

What are the types of carbon markets?

There are broadly two types of carbon markets that exist today— compliance markets and voluntary markets.

Voluntary Markets	Compliance Markets
Here, the Emitters— corporations, private individuals, and others— buy carbon credits to offset the emission.	Compliance markets are set up by policies at the national, regional, and/or international levels— that is officially regulated.
In voluntary markets, credits are verified by private firms as per popular standards.	Most of these markets operate under a principle called ‘cap-and-trade”.
Here the participants purchase emissions reductions for public relations or personal reasons.	Here the carbon offsets are created by the need to comply with a regulatory act
There are traders and online registries where climate projects are listed and certified credits can be bought.	Examples of compliance carbon markets are the: Kyoto Protocol European Union emissions trading system California emissions trading system (ETS) Australia ETS British Columbia ETS New Zealand ETS China launched the world’s largest ETS in 2021.

Cap-and-Trade vs Carbon Tax

A carbon tax and cap-and-trade are opposite sides of the same coin.
A carbon tax sets the price of CO₂ emissions and allows the market to determine the amount of reduced emissions.
A cap-and-trade system sets the quantity of emissions allowed, which can then be used to estimate the decline in the rise of global temperatures.
- The market price of carbon gets determined by market forces when purchasers and sellers trade in emissions allowance.

Advantages:

Related Indian Initiatives

PLI Scheme: Diversification of the supply chain by introducing a production-linked incentive scheme for the manufacturing of polysilicon cells into modules.
Clean Development Mechanism: In India, the clean development mechanism under the Kyoto Protocol provided a primary carbon market for the players.
Energy Conservation (Amendment) Bill, 2022

These markets may promote the reduction of energy use and encourage the shift to cleaner fuels.
Through this kind of carbon trading, companies can decide if it is more cost-efficient to employ clean energy technologies or to purchase additional allowances.
Since government-regulated trading schemes may prompt companies to innovate, invest in, and adopt cost-efficient low-carbon technologies.

What are the challenges to carbon markets?

Effectiveness of carbon markets: Some companies simply buy credits without making any effort to reduce emissions themselves.
- It is cheaper for them to buy carbon credit than to invest in emission-reducing technologies.
Environmental activists argue that only high-quality carbon offsets are effective in reducing emissions. High-quality carbon offsets have certain features:
- Additionality: Emission reductions must be additional i.e., they would not have occurred in the absence of a market for offset credits e.g., a renewable project could be set up only because a high emitter paid for it.
- Verifiable: There must be proper audits to ensure the monitoring, reporting, and verification of emission cuts.
- Permanence: The emission reduction should not be reversed.
However, many credits available in markets are of poor quality i.e., they do not meet the above criteria.
Buying carbon credits can deviate rich nations from the path of reducing emissions.
It is difficult to establish the amount of carbon reduced by offset projects (like afforestation or wind energy project).