Addressing the ticking climate clock
India has set a voluntary target of achieving net-zero emissions by 2070, necessitating a 45% reduction in the emissions intensity of its GDP by 2030. The demand for manufacturing and energy consumption is expected to go up – which will result in a further rise in emissions by 4.7% per year in Indian cities. Despite this goal, the demand for manufacturing and energy consumption is expected to rise, resulting in a projected annual increase of 4.7% in emissions within Indian cities. Industries such as power, steel, cement, transportation, agriculture, and construction have been significant contributors to greenhouse gas emissions, thus requiring a strategic and accelerated transition toward resilient low-carbon mechanisms. In the first article in our series on decarbonisation pathways, we explored various decarbonisation pathways available to businesses for reducing their carbon footprint. In this article, we will delve into the feasibility of carbon markets as a means for companies to decarbonise their own value chains, and towards a broader transition to net-zero.
As part of the Science-based Target Initiative (SBTi), 65 Indian companies in sectors like automobile, mining, electric utilities, and construction have committed to aligning themselves with the country’s Nationally Determined Contribution to decarbonisation. The SBTi, a global alliance empowering corporations to make their own pledges, promotes profitable but sustainable business action to combat climate change. However, Indian businesses, including micro, small, and medium-scale enterprises (MSMEs) contribute 110 million tonnes of CO2, encounter significant obstacles in achieving net-zero emission goals. The primary challenge lies in the lack of sufficient financing to develop innovative decarbonisation infrastructure, technologies, and services. Additionally, MSMEs often lack investment-grade credit ratings and robust Environmental, Social, and Governance (ESG) profiles, rendering the trillion-dollar global debt market inaccessible to them.
Presently, conventional climate funds are inadequate in supporting businesses’ efforts to adopt cost-effective and sustainable decarbonisation strategies in their raw material sourcing, production, transportation, and value chains. To address these limitations, carbon markets emerge as compelling market-based alternatives to help companies progress toward their decarbonisation objectives.
Carbon markets: Alternative solution to decarbonisation
India’s rapidly expanding carbon financing sector can play a pivotal role in providing financial solutions to businesses seeking to transition to greener practices. Carbon markets operate as trading systems where emission units, known as carbon credits, are bought and sold. Each tradable carbon credit represents one metric ton of CO2 emissions or an equivalent amount of GHG emissions avoided or sequestered. By employing carbon market mechanisms, awareness is raised regarding the environmental and social costs of emissions, encouraging investors and consumers to opt for lower-carbon alternatives.
As previously discussed in our articles, carbon markets fall into two main categories: the compliance market, also known as cap-and-trade, and the voluntary market. A cap-and-trade system establishes a mandatory limit (cap) on greenhouse gas emissions, and organisations exceeding these limits have the option to purchase excess allowances to meet their requirements or pay fines. In contrast, voluntary markets facilitate the trading of carbon credits outside the realm of regulatory obligations.
You can read our detailed working paper on this here: https://site.neufin.co/the-indian-carbon-market/
How can businesses benefit from carbon markets?
Carbon markets hold the potential to not only help businesses meet their climate financing needs but also usher countries towards achieving their Nationally Determined Contributions (NDCs). Here are some reasons why businesses may want to consider carbon financing as one of their decarbonisation pathways:
Access to carbon financing: Carbon markets serve as a valuable tool for mobilising private capital in a cost-effective manner. They offer several advantages, including providing certainty in cash flows and predictability in carbon revenues, thereby assisting in assessing the risk-reward profiles of targeted investments in projects. These markets also hold the potential to facilitate businesses in adopting and sustaining new climate-resilient technologies, infrastructure, and other capacities by offering consistent and adequate financial support for decarbonization initiatives.
One significant aspect of carbon markets is the pricing of emission reduction/removal, which varies based on the co-benefits they generate, such as gender and biodiversity conservation. This pricing differentiation reflects the diverse environmental and societal benefits associated with different emission reduction efforts within the carbon market framework.
The potential for financial returns through trading carbon credits encourages private entities to participate in climate-friendly projects. Revenue generated from the sale of carbon credits can be reinvested in sustainable projects, further promoting low-carbon technologies and practices. Carbon markets can also help attract private capital and investors interested in supporting sustainable projects. Businesses can access funding for green initiatives through carbon financing, thereby supporting their sustainability goals.
Risk Mitigation: As the global focus on climate change intensifies, businesses may face increased regulatory and reputational risks if they do not address their carbon footprint. Participation in carbon markets can help mitigate these risks by showcasing proactive efforts to reduce emissions.
For investors, carbon markets provide an avenue to make strategic decisions based on climate risk-adjusted returns from their investments in a company. By leveraging carbon offset mechanisms facilitated by these markets, investors can assess the physical and transition risks associated with a business. Additionally, this assessment helps gauge whether a company can position itself as a climate-conscious and energy-efficient entity, ultimately influencing its profit margins. In essence, a company’s engagement with carbon markets becomes a valuable parameter for evaluating its commitment to sustainability and its potential impact on financial performance.
Competitive advantage: Engaging in carbon markets and demonstrating a commitment to sustainability can enhance a company’s reputation and brand image. Customers, investors, and stakeholders are increasingly valuing environmentally responsible businesses, giving companies a competitive edge.
One of the primary obstacles to the widespread acceptance of carbon markets among businesses and investors is the concern that it might lead to reduced economic competitiveness. However, empirical evidence suggests that this impact is relatively minor. The underlying purpose of implementing a carbon pricing mechanism is to incentivize businesses, investors, and consumers to shift their preferences from carbon-intensive industries and processes to more environmentally friendly, low-carbon alternatives that are resilient to climate change.
The introduction of universally standardised carbon markets is expected to mitigate the risks of carbon leakage, which occurs when greenhouse gas emissions increase in countries with less climate-conscious policies due to emission reductions in other countries with stringent climate regulations. By implementing higher carbon pricing, industries and environmentally conscious entrepreneurs at the forefront of technology are encouraged to seize new market opportunities by branding and capitalising on their adoption of clean and sustainable alternatives.
As a result, businesses gain a first-mover advantage by swiftly and early adopting decarbonisation pathways, reaping reputational and financial benefits. This early adaptation enables companies to position themselves as leaders in sustainable practices, leading to increased recognition and support from consumers and investors alike. Ultimately, embracing carbon markets empowers businesses to thrive in a low-carbon economy while contributing to global efforts to combat climate change.
Direct support to Indian MSMEs: Indian MSMEs are integral to the nation’s economic progress and advancement. Nevertheless, they face challenges in securing adequate funding to modernise their infrastructure and capabilities, thereby transforming into low-carbon enterprises. Carbon markets offer a promising solution by providing much-needed financial support to these MSMEs, enabling them to invest in technological upgrades, embrace renewable energy solutions, and implement energy-efficient practices in their production processes. Consequently, participation in carbon markets may lead to reduced production costs for businesses while simultaneously promoting sustainability and climate resilience.
Way Forward
Amid the growing impacts of climate change, such as extreme heat and water scarcity, the rise in energy demand poses fiscal burdens and impacts economic competitiveness. In this context, carbon markets emerge as highly effective drivers for reducing emissions, providing the most cost-efficient means of achieving emission reductions. For instance, carbon financing is projected to prevent potential losses of up to $35 trillion resulting from unmitigated climate change over the next five decades.
Properly implemented, carbon market mechanisms can offer crucial support to domestic businesses, enabling them to offset their residual emissions during the transition to low-carbon energy sources. This, in turn, fosters a climate-conscious, energy-efficient, and climate-resilient approach within companies, thereby facilitating their contribution to mitigating climate change while sustaining their economic activities.
However, it is essential to acknowledge that carbon markets are not a stand-alone solution for achieving global decarbonisation objectives. They should be complemented by supportive policies, regulations, and other measures to drive substantial emission reductions and combat climate change effectively. Some industries may find it more economical to purchase carbon credits rather than invest in low-carbon technologies, which can inadvertently discourage heavy emitters from actively reducing their emissions.
To achieve the necessary emission reductions, a comprehensive approach that includes a combination of carbon pricing, technology advancements, renewable energy adoption, and sustainable practices is required. Carbon markets can be a valuable tool within this broader framework, encouraging businesses to embrace low-carbon alternatives and contribute to the collective effort to address climate change.
