By Lavkesh Balchandani
The carbon market’s role in project financing has evolved significantly, offering multiple pathways for capital deployment in emission reduction initiatives. The primary mechanism operates through the direct sale of carbon credits, where project developers receive revenue from credit purchases that help finance both initial implementation and ongoing operations. This revenue stream is particularly crucial for projects that might otherwise struggle to achieve financial viability through traditional funding sources.
Beyond direct credit sales, carbon markets facilitate project financing through several sophisticated instruments. Forward contracts and futures trading enable project developers to secure upfront funding by pre-selling expected carbon credits, providing essential capital for project implementation. These mechanisms help address the significant challenge of initial investment costs, particularly relevant for nature-based solutions and renewable energy projects that require substantial upfront capital.
Debt financing has emerged as another crucial tool, with specialised carbon bonds gaining traction. These instruments allow project developers to raise capital by leveraging future carbon credit revenues as collateral. The involvement of financial intermediaries, while adding complexity to the market structure, has expanded the pool of available capital and improved market liquidity. However, this financial sophistication also introduces new challenges in ensuring that adequate portions of carbon market revenues reach actual project implementation rather than being absorbed by intermediary costs.
The development of a carbon market is key as India aims to achieve its climate targets of reducing emissions intensity of its GDP by 45 per cent from 2005 levels by 2030 and ultimately reaching net zero emissions by 2070. Global trends in this space, especially after the conclusion of COP29, hold significance for the development of the Indian carbon market.
The new carbon market framework
The conclusion of COP29 in Baku, Azerbaijan, marks a pivotal moment in the evolution of global carbon markets, with new United Nations (UN)-supervised rules reshaping the landscape of emissions trading. For India, which has notified its own Carbon Credit Trading Scheme (CCTS), these developments present both significant opportunities and complex challenges.
The carbon market agreement at COP29 establishes clearer rules for assessing emission reduction claims and ensuring data integrity under UN supervision. The framework comprehensively addresses the placement of carbon trading mechanisms within the UN system, establishes guidelines for identifying eligible carbon credit projects, and creates standards for carbon removal and sequestration initiatives.
Under Article 6 of the Paris Agreement, two main market mechanisms have been further refined based on COP29 decisions. Article 6.2 facilitates bilateral or multilateral cooperation through internationally transferred mitigation outcomes (ITMOs), allowing countries to trade carbon credits to meet their climate targets. The COP29 decision mandates greater transparency, requiring public disclosure of ITMO approvals and establishing a consolidated authorisation accounting platform monitored by the United Nations Framework Convention on Climate Change Secretariat.
Meanwhile, Article 6.4 creates a centralised carbon market overseen by a designated supervisory body, introducing stricter requirements for removals and methodologies for emission reductions. The new framework includes comprehensive monitoring and reporting requirements, post-credit monitoring protocols and the establishment of a reversal risk buffer pool. This more rigorous approach aims to address previous concerns about the credibility of carbon markets.
From PAT to carbon credits
Against this international backdrop, India has made significant strides in developing its domestic carbon market. India’s carbon market ambitions build upon, and in some ways depart from, its decade-long experience with the Perform, Achieve and Trade (PAT) scheme. Launched in 2012 under the Energy Conservation Act, 2012, PAT focused strictly on energy efficiency improvements in energy-intensive industries. The scheme operated through clearly defined reduction targets for specific energy consumption, with industries that exceeded their targets earning energy saving certificates that could be traded. While this programme achieved some success, it also revealed significant implementation challenges, including the inconsistent achievement of targets across industrial sectors and technical difficulties in trading platform operations.
The 2023 notification of the CCTS marks a significant expansion in scope and ambition. The CCTS aims to operate through dual mechanisms: a mandatory compliance component targeting high-emission sectors and a voluntary offset mechanism enabling broader participation. The compliance mechanism focuses on sectors such as cement production, iron and steel manufacturing, pulp and paper industry, and petrochemical production, requiring obligated entities to either meet greenhouse gas emission intensity targets or purchase carbon credits for compliance.
The offset mechanism takes a more inclusive approach, encouraging participation across the energy sector, waste management, agriculture, forestry and transportation. This broader scope creates opportunities for innovation and investment in sustainable practices across the economy, though it also introduces new complexities in implementation and oversight.
The Bureau of Energy Efficiency (BEE) will serve as the primary administrator for the CCTS, building on its experience with PAT. However, the expanded scope introduces new challenges in technical expertise requirements and administrative capacity. The stringent requirements for accreditation, while necessary for market integrity, have created potential bottlenecks in verification processes and increased compliance costs for market participants. This situation requires careful attention to balance market credibility with operational efficiency.
Implications and opportunities
The COP29 framework provides significant opportunities for India’s carbon market development through enhanced credibility and potential international integration. Alignment with international standards opens possibilities for cross-border trading and investment, access to global carbon finance mechanisms and technology transfer opportunities. India’s position in the global carbon market is strengthened by its large-scale emission reduction potential and diverse sectoral participation opportunities.
To ensure successful market operation, India must prioritise several key areas of development. Technical capacity building remains crucial, particularly in specialised expertise for emissions verification and data management. Market infrastructure requires continued enhancement, including robust trading platforms, efficient registry systems and effective oversight mechanisms.
The policy framework must balance multiple objectives, including gradual market expansion, environmental integrity and economic efficiency. Support mechanisms for affected sectors need careful consideration to maintain industrial competitiveness while advancing climate goals. Integration with existing climate policies requires strategic coordination to avoid overlapping or conflicting requirements.
Market integrity remains a paramount concern, requiring robust institutional frameworks and technical expertise. While the new international rules provide clearer guidelines, implementing these effectively requires significant capacity building and resource allocation. This challenge is particularly relevant for developing countries like India, which must balance environmental objectives with development priorities.
Carbon pricing mechanisms have the risk of placing disproportionate burdens on developing economies. The costs associated with measuring and verifying emissions at the granular level required by international standards can be substantial, potentially limiting market participation. These considerations must inform the ongoing development of India’s carbon market framework.
The success of the CCTS will largely depend on how well it addresses these various challenges while maintaining environmental integrity and economic efficiency. The scheme’s ability to deliver real emissions reductions while supporting India’s development objectives remains to be proven, and the additional requirements emerging from COP29 add further complexity to an already challenging transition.
Another key focus area within carbon markets is with respect to the concept of additionality. For projects to be considered “additional”, it is essential that the emission reductions from those projects would not have occurred without the revenue from carbon credit sales, serving as a fundamental criterion for project validation. This principle helps ensure that carbon markets drive genuine climate action rather than simply rewarding business-as-usual activities.
For India’s CCTS, implementing robust additionality criteria presents both challenges and opportunities. Thus, going forward, projects must demonstrate that carbon credit revenue is essential for their financial viability. This is particularly relevant for renewable energy projects in India, where rapidly declining technology costs have led to the decline of genuine additionality.
The way forward
As India advances its carbon market ambitions, a realistic assessment of capabilities and constraints becomes increasingly important. The focus should remain on building robust foundations, including technical capacity, institutional frameworks and market infrastructure, before pursuing more ambitious market mechanisms.
Looking ahead, the short-term focus must remain on establishing reliable baseline data and building verification capacity. Medium-term objectives should include expanding market participation and deepening market liquidity, while long-term goals encompass full integration with global carbon markets and comprehensive sector coverage. The gradual roll-out of new international requirements provides some time for adaptation but also creates pressure to align systems and processes efficiently. Going forward, the experiences of other carbon markets, particularly the EU Emissions Trading System, offer valuable lessons on price volatility and market stability and should inform India’s approach.
The integration of robust additionality frameworks and diverse financing mechanisms will be crucial for the CCTS’s long-term success. Success in these areas will not only strengthen the credibility of India’s carbon market but also enhance its potential for international integration and environmental impact.
