Carbon market

Topic: Environment and Sustainable Development · NCERT: Beyond NCERT

Meaning

A carbon market is a market where people buy and sell carbon credits or emission allowances. Each unit stands for 1 tonne of CO₂e (carbon dioxide equivalent: other greenhouse gases are converted into the amount of CO₂ that would cause the same warming). The unit is either the right to emit that tonne, or proof that a tonne was reduced, avoided or removed.

It matters because it puts a price on pollution. Emissions stop being "free". The market then finds out which firms can cut emissions most cheaply. India built its own carbon market through the Carbon Credit Trading Scheme (CCTS), 2023 [2].

Explanation

Why a carbon market is needed

• Pollution is a negative externality. An externality is a cost that falls on people outside a deal.
• A coal plant pays for fuel, labour and capital.
• It does not pay for the smoke that harms lungs, farms and the climate.

• So its power looks cheaper than it really is, and society uses too much of it.

• Marginal social cost (MSC) = marginal private cost (MPC) + marginal external cost (MEC)

• Internalisation means making the polluter bear the full social cost, so that cost shows up in its own accounts.
• There are two main ways to price carbon:
• A carbon tax fixes the price per tonne. How much emissions will fall stays uncertain.
• Cap-and-trade, also called an ETS (Emissions Trading System), fixes the quantity, meaning total emissions. The permit price stays uncertain. A carbon market is how cap-and-trade works in practice.

How trading works: the two traded units

• Allowance (used in cap-and-trade)
• The regulator sets a cap on total emissions and issues exactly that many allowances. 1 allowance = the right to emit 1 t CO₂e.
• Firms that can cut emissions cheaply cut more than they need to and sell their spare allowances.
• Firms that find cutting expensive buy them instead.

• Result: the cap is met at the lowest total cost.

• Carbon credit (used in offsets)

• This is a certificate for 1 t CO₂e reduced, avoided or removed by a project, such as a solar farm or a forest.

• Carbon offset: buying credits to cancel out your own emissions.

• Worked example: why trading saves money

• Firm A can cut CO₂ for ₹500/t. Firm B can cut CO₂ for ₹3,000/t. The cap requires a total cut of 100 t.
• Without trading, each firm cuts 50 t: (50 × 500) + (50 × 3,000) = ₹1,75,000.
• With trading, A cuts all 100 t for ₹50,000 and sells 50 permits to B. The permit price settles somewhere between ₹500 and ₹3,000.
• The cap is the same, but society saves ₹1,25,000.

Types of carbon market

	Compliance market	Voluntary carbon market (VCM)
Created by	Law	Buyers' own choice
Who takes part	Covered entities. They must hand in allowances or credits equal to their emissions	For example, companies with net-zero pledges
Examples / standards	EU ETS (2005); China national ETS (2021); India's CCTS compliance mechanism	Verra, Gold Standard, ICVCM's Core Carbon Principles (a quality benchmark)

• International layer: from Kyoto to Paris
• CDM (Clean Development Mechanism), under the Kyoto Protocol
  • Developed countries paid for emission-cutting projects in developing countries.
  • In return they earned CERs (Certified Emission Reductions), which counted towards their own targets.
  • India was the second-largest host after China.
• Paris Agreement, Article 6.2: ITMOs (Internationally Transferred Mitigation Outcomes)
  • These are country-to-country transfers of emission cuts.
  • They need corresponding adjustments: the selling country adds the tonne back to its own account, so the cut is not counted twice.
• Paris Agreement, Article 6.4: PACM (Paris Agreement Crediting Mechanism)
  • This is a UN-supervised system that replaced the CDM.
  • Its rules were finalised at COP29 (Baku, 2024), with standards on baseline, leakage and reversal [6].
  • The UNFCCC says Article 6 could help save up to US$250 billion a year in the cost of carrying out national climate plans [6].

What makes a credit trustworthy: the four integrity tests

• Additionality: the cut would not have happened without the credit money.
• Permanence: the carbon stays locked away. A forest that later burns releases it again.
• No leakage: emissions do not simply move to another place.
• No double counting: the same tonne is not claimed by two buyers or two countries.
• Warning case: some REDD+ credits (Reducing Emissions from Deforestation and forest Degradation) faced integrity scandals. The deforestation they claimed to have "avoided" was overstated.
• Global spread
• Carbon pricing covers about 28% of global GHG emissions (2025).
• There are 80 instruments in operation: 43 carbon taxes and 37 ETSs [5].
• Carbon pricing revenue exceeded US$100 billion in 2024 [4].

In India

• India has no economy-wide carbon tax. It moved step by step towards a domestic carbon market:
• Step 1: PAT (Perform, Achieve and Trade), 2012
  • Energy-intensive plants get energy-saving targets.
  • Plants that beat their target earn ESCerts (Energy Saving Certificates). Plants that miss it buy them.
• Step 2: RECs (Renewable Energy Certificates)
  • These are tradable proof that renewable power was generated.
  • Discoms (power distribution companies) buy them to meet their renewable purchase obligations.
• Step 3: Energy Conservation (Amendment) Act, 2022
  • This gave the government legal power to set up a carbon credit trading scheme.

• Step 4: CCTS, notified in June 2023

  • It created the Indian Carbon Market (ICM) and the National Steering Committee for the Indian Carbon Market (NSCICM) [2].
  • It aims to cut GHG emissions by pricing them through tradable Carbon Credit Certificates (CCCs) [2].

• Who does what

• BEE (Bureau of Energy Efficiency): administrator
• Grid-India: registry, which keeps the record of who holds which credits

• CERC (Central Electricity Regulatory Commission): regulates trading

• (a) Compliance mechanism

• Obligated Entities must meet GHG Emission Intensity (GEI) targets. These are measured as t CO₂e per tonne of product, not as an absolute cap [2][3].
• Entities that beat their target earn CCCs and sell them. Entities that miss it buy them [2].
• The first targets covered 7 sectors moved over from PAT: aluminium, cement, chlor-alkali, petrochemicals, petroleum refineries, pulp and paper, textiles [2].

• Later, GEI targets were notified for 208 more carbon-intensive industrial units [1].

• (b) Offset mechanism

• Entities that are not obligated can voluntarily register projects and earn credits.

• Worked example: intensity target

• A cement plant's target is 0.60 t CO₂e per t of cement, and it produces 10 lakh t. Allowed emissions = 6 lakh t CO₂e.
• Its actual intensity is 0.57 t, so it emits 5.7 lakh t. It earns 30,000 CCCs (1 CCC = 1 t CO₂e), which it can sell.

• Total emissions can still rise if output grows. This fits India's NDC (its national climate pledge), which is set as an emissions-intensity-of-GDP target (emissions per rupee of GDP).

• International links

• India notified its list of activities eligible under Article 6.2 in 2023.
• A working domestic carbon price can help Indian exporters ask for a deduction under the EU CBAM (Carbon Border Adjustment Mechanism), because carbon already paid for at home can reduce the charge.

Don't confuse with

• Carbon tax: the government fixes the price and the emission cut stays uncertain. In a carbon market (cap-and-trade), the quantity is fixed and the price is set by trading.
• Green Credit (Green Credit Programme): it rewards actions such as tree planting or water conservation. It is not a certified tonne of CO₂e, so it is not a carbon credit.
• Allowance vs carbon credit: an allowance is a right to emit 1 t, issued under a cap. A carbon credit is proof that 1 t was reduced, avoided or removed by a project.
• ESCert (under PAT): it is counted in energy saved, not in tonnes of CO₂e. PAT sectors were later moved into the CCTS.

Prelims Hooks

• 1 carbon credit = 1 t CO₂e reduced, avoided or removed. 1 allowance = the right to emit 1 t CO₂e.
• CCTS (June 2023) was notified under the Energy Conservation (Amendment) Act, 2022. BEE is the administrator, Grid-India the registry and CERC the trading regulator [2].
• CCTS targets are emission intensity (GEI) targets, not absolute caps. The first 7 sectors came from PAT: aluminium, cement, chlor-alkali, petrochemicals, refineries, pulp & paper, textiles [2].
• EU ETS began in 2005. China's national ETS began in 2021. Worldwide there are 80 pricing instruments (43 taxes, 37 ETSs), covering about 28% of global emissions in 2025 [5].
• Article 6.2 = ITMOs (country-to-country, with corresponding adjustments). Article 6.4 = PACM, the successor to the CDM, with rules finalised at COP29 (2024) [6].
• Trap: Green Credit ≠ carbon credit. A compliance market is set up by law, while in the voluntary market buyers offset by choice.

Mains Points

• Intensity vs absolute cap
• An intensity-based market (CCTS) protects growth, because output can rise, while still rewarding efficient plants.
• But it does not guarantee that total emissions fall.

• A carbon tax gives certain revenue and is simpler to run, which suits a country with limited monitoring capacity.

• Integrity decides credibility

• Additionality, permanence, leakage and double counting decide whether credits reflect real cuts.
• The REDD+ scandals show the risk of greenwashing (claiming green credentials that are not real).
• Corresponding adjustments under Article 6 and the COP29 standards (baseline, leakage, reversal) help [6].

• India needs strong MRV (Monitoring, Reporting and Verification) for its offset mechanism.

• Carbon market as a trade shield (GS-II/III)

• The EU CBAM charges imports for their embodied carbon (the emissions released while making a product). This hits Indian steel and aluminium exports.
• India calls CBAM unilateral and against CBDR (Common But Differentiated Responsibilities: rich countries, which caused most past emissions, should carry more of the burden).
• A credible domestic carbon price under the CCTS gives India a basis to seek a CBAM deduction. It also supports green steel and aluminium technology.

Related concepts

• Internalisation of externalities
• Carbon pricing
• Green tax
• Social cost of carbon
• Internal carbon price
• Fossil fuel subsidies
• Cap-and-trade
• Compliance carbon market
• Voluntary carbon market
• Carbon credit

Read more

• Pricing pollution: carbon taxes, cap-and-trade and carbon markets