The recently concluded COP29 in Baku did not hit the headlines as prominently as some previous COPs. Comparatively, it was a tame affair. And yet, it registered some progress. The key outcomes of the deliberations included an agreement to put in place a UN-administered carbon trading framework; a structured operationalisation plan for the Loss and Damage Fund with contributions from developed countries and new donors, including private sector partnerships; and agreements on scaling investments in ecosystems, such as forests and wetlands, to sequester carbon and enhance resilience. Wealthier nations also pledged to meet and exceed the $100 billion annual climate finance goal, focusing on adaptation in vulnerable regions. While these outcomes may not seem groundbreaking, they represent incremental progress.
Among these, the most significant outcome—with extensive ramifications—is the agreement on Global Carbon Credit Standards. Nations finalised rules under Article 6 of the Paris Agreement, establishing a UN-administered carbon trading framework. This agreement aims to enhance transparency, accountability, and reduce greenwashing concerns while supporting private and state-level carbon credit exchanges. The approved standards are expected to mobilise significant investments, potentially driving the carbon credit market’s value to $250 billion annually by 2030, aligning carbon offsets with ambitious climate targets. These developments represent a crucial step in operationalising international efforts to combat climate change.
PROVISIONS OF THE BAKU AGREEMENT
The Baku Agreement operationalises Article 6 of the Paris Agreement and provides a global framework for carbon markets. It introduces standardised rules to prevent double counting of carbon credits and ensure environmental integrity. The operationalisation of Article 6.4 establishes a centralised market mechanism to replace the Clean Development Mechanism (CDM), supporting sustainable development and encouraging nations to adopt more ambitious climate targets.
WHAT IS CARBON TRADING?
Carbon trading, also known as emissions trading, is a market-based mechanism aimed at reducing greenhouse gas (GHG) emissions. The concept revolves around setting a cap on emissions and allowing entities to buy and sell emission allowances or credits. There are two primary forms of carbon trading: Cap-and-trade systems and offset markets.
In cap-and-trade systems, governments set an overall limit (cap) on emissions. Companies receive or buy permits (allowances) to emit up to a certain level and can trade unused allowances. Offset markets, on the other hand, enable entities to invest in projects that reduce or absorb emissions, such as afforestation or renewable energy projects, and earn carbon credits that can be sold to offset their emissions.
ORIGINS AND EVOLUTION OF CARBON TRADING
The idea of carbon trading emerged from economic theories advocating market-based solutions to environmental issues. Its formal genesis began with the economic theories of the 1960s and 1970s, when economists like Ronald Coase theorized about pricing externalities (e.g., pollution) to encourage sustainable practices.
The Kyoto Protocol of 1997 was a watershed moment in the institutionalisation of carbon markets, introducing mechanisms like the Clean Development Mechanism (CDM) and Joint Implementation (JI) to allow countries to trade emissions and meet reduction targets. Since then, carbon trading has evolved significantly. The European Union Emissions Trading System (EU ETS), launched in 2005, became a model for cap-and-trade systems, inspiring similar initiatives worldwide. The Paris Agreement in 2015 further emphasised national commitments (Nationally Determined Contributions, or NDCs) and established Article 6, outlining guidelines for international carbon markets. Voluntary Carbon Markets (VCMs) also emerged, reflecting growing private sector interest.
CARBON TRADING: PROMISES AND CHALLENGES
The operationalisation of Article 6 of the Paris Agreement following the Baku Agreement has brought carbon trading to the forefront of global climate action. While this mechanism has several promising aspects, it also presents significant challenges.
Carbon trading offers cost-effectiveness by ensuring that reductions occur where they are most economically viable, encouraging innovation and fostering investments in cleaner technologies. It facilitates global collaboration, transferring funds and technologies to developing nations, and supports sustainable development by financing resource-rich projects in developing countries.
However, challenges like market volatility, weak caps, and excess allowances undermine the system’s effectiveness. Fluctuating prices of carbon credits create uncertainty for investors and stakeholders and issues like the ‘hot air’ phenomenon observed during the early phases of the EU-ETS undermine the system’s effectiveness. Double counting and leakages pose serious threats to the system’s integrity, while ethical concerns argue that carbon trading commodifies nature, allowing wealthier nations to bypass their responsibilities by purchasing credits.
INDONESIA: A CASE STUDY
In a recent article in Yale’s E360, the case of Indonesia which has eagerly embraced the new agreement has been analysed. Indonesia, with its vast forests and potential for carbon sequestration, exemplifies both the promises and pitfalls of carbon trading. The country has been proactive in leveraging its natural resources to generate carbon credits, attracting significant international investments. Yet, its carbon trading ventures have exposed systemic flaws in global carbon markets.
This southeast Asian giant is home to the third largest expanse of tropical rainforests and more than a third of another of the world’s great carbon stores, peatlands. And it plans to raise up to $65 billion by 2028 from selling carbon credits accrued from restoring and protecting its forests and peatlands—developing what the Indonesia government terms as ‘restorative economy’.
Indonesia’s strategy focuses on two main pillars: Peatland Restoration and Forest Conservation. Peatland restoration builds on earlier efforts to rewet drained peatlands to curb carbon emissions and reduce fire risks. However, critics argue the effectiveness of rewetting efforts is questionable, with incomplete adherence to water table targets and continued emissions from partially restored areas. Forest conservation includes flagship projects like Katingan Mentaya that claim to protect biodiversity while selling carbon credits. The initiative supports local economies but faces scrutiny over inflated carbon credit claims and questionable assumptions about potential deforestation without the project.
Notwithstanding the many merits of carbon trading, and Indonesia’s enthusiastic embrace of the new agreement, concerns about integrity, transparency, and environmental effectiveness surround this enthusiasm.
Firstly, there are accounting issues. Doubts linger over inflated baseline scenarios, with studies showing that only 25% of carbon credits linked to avoided deforestation deliver real emission reductions.
The second apprehension is about Double Counting, where emission reductions are claimed by multiple entities. Carbon credits risk being claimed for multiple purposes (e.g., meeting Indonesia’s national targets while being sold internationally), undermining global carbon goals. This issue undermines the integrity of the market and dilutes its environmental benefits.
Thirdly, critics highlight the absence of robust compliance mechanisms and transparency under the Baku framework, raising fears of fraud.
Verification challenges also persist, as accurately measuring and verifying emissions reductions in remote forest areas is complex and resource intensive. Furthermore, social conflicts arise when carbon offset projects, such as large-scale reforestation initiatives, encroach on local communities’ land rights, leading to disputes and potential human rights violations.
SYSTEMIC FLAWS
Indonesia’s experiences expose systemic flaws in global carbon markets, such as inflated claims and insufficient regulation. As more countries adopt peatland restoration strategies, better scientific data and governance will be essential to ensure these efforts contribute genuinely to climate targets. It also highlights the need for robust governance and transparency in carbon markets. Strengthened monitoring, reporting, and verification systems, coupled with independent evaluation, are essential to address these challenges. Balancing offset projects with direct emissions reduction efforts is crucial to ensure alignment with national climate goals.
The risk that looms ahead is these flaws escalating into wholesale carbon fraud. And if the mistakes are replicated in other countries, they could seriously undermine the world’s efforts to fight climate change.
COWBOY CARBON MARKET?
But for now, the danger is that the loose rules for carbon trading adopted in Baku—with their potential for secrecy and lack of oversight or enforcement—increase this risk. As one of the experts has poignantly pointed out that the existing set of rules ‘risk facilitating cowboy carbon markets at a time when the world needs a sheriff’.
Carbon trading represents a pragmatic approach to addressing climate change, blending market mechanisms with environmental stewardship. Its success, however, depends on stringent regulation, transparency, and equitable frameworks. The Indonesian venture typifies both the benefits and risks of carbon markets, illustrating the potential for future manipulation. A better understanding of the way the carbon markets may operate should naturally reveal both the strengths and weaknesses, and while the strengths will need to be reinforced, the many weaknesses will need to be plugged. For this landmark initiative to succeed, to harness its benefits, and to mitigate the many pitfalls, striking the right balance is both critical and imperative. If developed honestly, it may as well be a key weapon in the fight against climate change.
THE BAKU AGREEMENT ON CARBON TRADING: IMPLICATIONS FOR INDIA
India has long stood at the forefront of global environmental initiatives, navigating a complex balance between developmental aspirations and international climate commitments. The recent Baku Agreement, which aims to operationalise Article 6 of the Paris Agreement, marks a pivotal moment for India, presenting significant opportunities and challenges in the realm of carbon trading.
INDIA’S HISTORICAL STANCE
India has historically supported carbon trading as an essential tool for mitigating climate change but has approached it cautiously. This stance reflects the nation’s dual priorities of sustainable development and equitable growth. While India does not yet have a fully operational nationwide carbon trading system, it has actively participated in international mechanisms like the Clean Development Mechanism (CDM) under the Kyoto Protocol. This involvement saw India host numerous CDM projects, attracting foreign investment and facilitating technology transfer for emission reduction initiatives.
DOMESTIC INITIATIVES
Domestically, India has introduced several initiatives to promote carbon trading and energy efficiency. The Perform, Achieve, and Trade (PAT) Scheme, launched in 2012 under the National Action Plan on Climate Change (NAPCC), allows industries to trade energy-saving certificates (ESCerts). Similarly, the Renewable Energy Certificate (REC) Mechanism facilitates the trading of certificates linked to renewable energy generation. In August 2023, India proposed a Carbon Credit Trading Scheme (CCTS), signalling its intent to establish a formal domestic carbon market. Throughout, India has emphasised equitable access to these mechanisms, advocating for technology transfer and financial support for developing nations under the Paris Agreement framework.
BENEFITS OF CARBON TRADING
A robust carbon trading system offers India numerous benefits. It could attract foreign investment and generate revenue by monetising the country’s low-carbon initiatives. Such a system would also enhance India’s global leadership in sustainable development and climate diplomacy. By incentivising industries to adopt cleaner technologies, carbon trading can accelerate India’s transition to a low-carbon economy. The creation of green jobs in renewable energy, energy efficiency, and carbon sequestration sectors would also contribute to socio-economic development. Leveraging its extensive forest cover and renewable energy potential, India is well-positioned to capitalise on global offset markets.
CHALLENGES
However, challenges persist. Equity concerns must be addressed to ensure inclusion of smaller businesses and marginalised communities. Establishing a transparent and efficient carbon trading system requires robust institutional frameworks, while over-reliance on exporting carbon credits could detract from addressing domestic emissions. Ensuring the environmental integrity of offset projects is crucial to maintaining credibility.
OPPORTUNITIES FOR INDIA
For India, the Baku Agreement opens several pathways. Integration into international carbon markets could position the country as a major supplier of carbon credits, leveraging its renewable energy projects, afforestation programmes, and energy efficiency initiatives. Aligning domestic carbon trading policies with global standards could also attract international participants, enhancing the credibility and appeal of India’s markets. By actively engaging in implementation of the agreement, India can solidify its leadership role in climate negotiations. Moreover, the agreement will likely drive investments in climate-friendly technologies, furthering India’s decarbonisation efforts.
CONCLUSION
India’s engagement with carbon trading represents a strategic opportunity to harmonise its developmental aspirations with global climate responsibilities. The Baku Agreement, with its standardised framework and ambitious goals, amplifies these opportunities. To realise these benefits, India must establish robust regulatory mechanisms to address equity concerns, ensure transparency, and uphold environmental integrity. India can then maximise advantages of global carbon markets and cement its reputation as a leader in the fight against climate change. The Baku Agreement presents a critical opportunity to address these concerns. By integrating safeguards, adopting transparent practices, and emphasising equity, India can position itself as a responsible leader in global climate action, transforming the challenges of carbon trading into avenues for innovation and sustainable growth.
* The writer, a Harvard educated civil servant, is a former Secretary to the Government of India. He also served on the Central Administrative Tribunal and as Secretary General of ASSOCHAM. He commands extensive expertise in the fields including Media and Information, Industrial and Labour Reforms, and Public Policy.
