Background

On March 27, 2023, India's Power Ministry ("MoP") released a copy of a draft carbon credit trading scheme ("CCTS," and such draft CCTS, the "Draft CCTS") among relevant stakeholders (comprising a few key industry bodies).

This exercise was undertaken pursuant to the MoP's authority to do so under the Energy Conservation Act, 2001 (the "EC Act"), as recently amended by the Energy Conservation (Amendment) Act, 2022 (the "2022 Amendment").

Further to the 2022 Amendment, which came into force on January 1 this year, the EC Act now empowers the central government ("CG") to specify the CCTS through notification, in consultation with the Bureau of Energy Efficiency ("BEE"). In the present instance, the MoP represents the CG, being the nodal ministry with respect to the matter.

The Draft CCTS

While the deadline for feedback and comments to the Draft CCTS lapsed on April 14, 2023, additional consultations involving other stakeholders continued for a few weeks after its release, including those conducted with accredited energy auditors, carbon and/or energy verifiers, and sectoral experts. Further to such consultations and based on comments received, a more detailed version of the Draft CCTS was expected be released soon.

Simultaneously and thereafter, the BEE worked on developing a revised version of the Draft CCTS under the MoP's supervision, along with the Ministry of Environment, Forest and Climate Change ("MoEFCC"). The ultimate objective of this exercise was to decarbonize the Indian economy by pricing 'greenhouse gas' ("GHG") emissions through the trading of carbon credit certificates ("CCCs").

The Final CCTS

More recently, pursuant to a gazette notification dated June 28, 2023, the MoP, in consultation with the BEE, issued the 'Carbon Credit Trading Scheme, 2023' (the "Final CCTS"). The Final CCTS came into force on June 30, 2023, i.e., the date of its publication in India's official gazette.

The 2022 Amendment

In general, Section 14 of the EC Act authorizes the CG to enforce efficiency with respect to the use and conservation of energy. Late last year, among other changes, sub-section (w) was inserted under Section 14 of the EC Act via Section 6(viii) of the 2022 Amendment. As such, the 2022 Amendment marks only the second instance when the EC Act has been amended.

Among other things, certain newly added provisions expressly authorize the CG (i.e., the MoP) to issue CCCs to such registered entities that comply with the requirements of the Final CCTS.

This note discusses India's CCTS, including through the prism of its legislative and regulatory history, along with the administrative apparatus connected with the scheme. In the next note, we will place these developments in context, within the wider framework of integrated energy markets.

Regulatory History

The EC Act was first amended in 2010 (the "2010 Amendment") to expand upon the scope of the original legislation, including through the establishment of a trade-based regulatory framework – known as 'Perform, Achieve and Trade' ("PAT") – for the purpose of reducing energy consumption in energy-intensive industries. The framework under PAT involves certifications related to excess energy savings (such energy saving certificates, "ESCerts"). Further to the 2010 Amendment and certain allied rules on PAT (the "PAT Rules"), ESCerts have been issued to designated consumers ("DCs") under qualifying conditions. Meanwhile, PAT involves ESCert trading between over-performing and under-performing DCs, as explained below.

The 2010 Amendment

The 2010 Amendment expanded upon Section 14(e) of the EC Act, which in its original form authorized the CG – in consultation with the BEE – to specify any one or class of energy users as a DC for the purpose of the EC Act. However, the 2010 Amendment clarified that such DC specifications were required to be made from only among those energy-intensive industries and establishments which were separately specified in an amended schedule to the EC Act.

Further, the 2010 Amendment added Sections 14A and 14B to the EC Act. Sub-section (1) of the newly-inserted Section 14A empowered the CG to issue ESCerts to those DCs whose energy consumption remained less than the norms and standards prescribed through appropriate procedure (the "Specified Standards"). Alternatively, pursuant to sub-section (2), if a DC's energy consumption was more than the Specified Standards, it was entitled to purchase ESCerts for the purpose of securing compliance.

Moreover, the new Section 14B authorized the CG – in consultation with the BEE – to prescribe the value of energy consumed for the purpose of the EC Act in terms of per metric ton of oil equivalent ("MTOE"). Thus, after the 2010 Amendment took effect, bespoke rules were framed under the EC Act – such as the "PAT Rules" – which were issued two years later, and continue to be amended periodically. The last time that the PAT Rules were amended was in 2022.

PAT

Introduced for the purpose of improving energy efficiency among DCs within key sectors, PAT seeks to establish a specific methodology to determine norms related to specific energy consumption ("SEC") – i.e., the energy used per unit of production – for each DC in a baseline year, as well as in subsequent target years, with the ultimate aim of reducing the SEC in large, energy-intensive industries. Such targets were originally based on the annual SEC for each DC in the baseline year (2010), as adjusted to account for factors such as product mix, capacity utilization, change in fuel quality, import/export of power, and other factors.

Pursuant to an energy audit performed under PAT to verify the baseline data (i.e., current levels of efficiency) and corresponding energy targets, ESCerts may be issued to those plants that achieve energy savings in excess of their targets. Entities which are unable to meet such targets either through their own actions or via the purchase of ESCerts may incur financial penalties under the EC Act. After ESCerts are issued to them, and further to registering with relevant power exchanges – viz., Indian Energy Exchange Limited (IEX) and Power Exchange India Limited (PXIL), DCs may trade in such ESCerts on electronic platforms maintained with those power exchanges.

Importance of the 2022 Amendment

Along with sub-section (w), the 2022 Amendment also added sub-section (x) to Section 14 of the EC Act, pursuant to which the CG, in consultation with the BEE, is now authorized to specify a minimum share of consumption with respect to non-fossil sources by DCs as energy or feedstock. Further, a different share of consumption may be specified for different types of non-fossil sources for different DCs.

The 2022 Amendment also inserted a new Section 14AA ('Issuance of carbon credit certificate') to the EC Act. With effect from January 2023, and pursuant to Section 14AA(1) of the amended EC Act, any agency authorized by the CG (other than the CG itself) may issue CCCs to such registered entities that comply with the requirements of the CCTS specified by the CG. Accordingly, under Section 14AA(2), such registered entities will be entitled to buy or sell CCCs pursuant to the CG-specified CCTS under Section 14(w) of the amended EC Act.

In addition, Section 14A of the EC Act (dealing with the issuance of ESCerts) was further modified by the 2022 Amendment. Pursuant to such modification, Section 14A now allows any agency authorized by the CG – and not just the CG itself – to issue ESCerts to those DCs whose energy consumption remains less than the Specified Standards. Importantly, the 2022 Amendment also added a proviso to sub-section (2) of such Section 14A – thereby permitting 'any other person' (i.e., any entity/person other than DCs) to voluntarily purchase either ESCerts or CCCs.

Previously under the EC Act – even after the 2010 Amendment – (i) only the CG could issue ESCerts as part of the PAT framework (and no other entity could – not even an agency authorized by the CG itself); and (ii) only DCs (and no other entity or person) could purchase ESCerts, even if a non-DC entity wanted to buy such certificates on a voluntary basis.

The changes introduced by the 2022 Amendment are especially significant in light of the surplus supply of ESCerts under PAT, which aspect will be discussed separately in our next note.

The CCTS

Earlier, the Draft CCTS had essentially outlined a scheme for the reduction or removal of GHG emissions, consistent with the definition of GHGs by the United Nations Framework Convention on Climate Change ("UNFCCC"). Subsequently, Section 2(h) of the Final CCTS specified that GHGs represent those gaseous constituents of the atmosphere, both natural and anthropogenic, that absorb and re-emit infrared radiation. Accordingly, GHGs include, but are not limited to, carbon dioxide (CO2), methane (CH4), nitrous oxide (N2O), hydrochlorofluorocarbons (HCFCs), hydrofluorocarbons (HFCs), perfluorocarbons (PFCs), and sulfur hexafluoride (SF6).

The Draft CCTS had contemplated both a compliance and a voluntary regime, while the Final CCTS does not refer to the latter – except to the extent that non­-obligated entities can purchase CCCs on a voluntary basis. However, under the Draft CCTS, non-obligated entities had been permitted to voluntarily register their respective projects for reducing or removing GHG emissions for the purpose of getting CCCs issued in their favor.

On the other hand, under the compliance regime – the framework for which has remained the same – obligated entities will need to adhere to prescribed GHG emission norms, as notified by the CG.

Obligated and Non-Obligated Entities

'Obligated entities' are those which are required to register for the Final CCTS, as notified under the latter's compliance mechanism, including DCs. On the other hand, 'non­-obligated entities' – while nevertheless requiring registration under the CCTS – are those which can purchase CCCs on a voluntary basis. Nevertheless, as mentioned above, unlike the Draft CCTS, the Final CCTS makes no mention of whether such non­-obligated entities can register their projects for CCC issuances.

CCCs

The Final CCTS defines a 'carbon credit' to mean a value assigned to a reduction or removal or avoidance of GHG emissions, which is equivalent to one ton of carbon dioxide equivalent (such measure, "tCO2e"). CCCs may be issued by the CG (or any agency authorized by it) to registered entities under Section 14AA of the EC Act. Under the Draft CCTS, such issuances could be made under either of the compliance or voluntary mechanisms, respectively, as long as the issuances were within the overall scheme of the CCTS. Nevertheless, the Final CCTS states that a detailed procedure – which may be later developed for the purpose of operationalizing the Indian carbon market in accordance with the finalized scheme – will contain, among other things, the criteria for CCC issuances.

CCCs can only be issued pursuant to evaluative exercises conducted by a BEE-accredited agency ("Accredited Carbon Verifier," or "ACV"). Earlier, within the operational and evaluative scope of an ACV, the Draft CCTS had included acts such as project validations (for the voluntary mechanism) and/or verification of activities undertaken by a registered entity (for either of the compliance or voluntary mechanisms). However, the Final CCTS merely specifies that an ACV will be required to perform functions for the purpose of the finalized scheme as determined by the BEE from time to time.

Further, the BEE will determine, with prior CG approval, the exact procedure (including in respect of eligibility criteria) for agency accreditations with respect to functioning as an ACV, further based on the recommendation of a national steering committee for the Indian carbon market ("ICM," and such committee, the "NSC"). The Final CCTS has replaced the governing board of the ICM (such erstwhile board, the "ICMGB") – as previously contemplated under the Draft CCTS – with the NSC.

The BEE's Role

Consistent with its general role and statutory duties under the EC Act, the BEE is involved with the issuance of ESCerts and their trading under PAT. Pursuant to the 2022 Amendment and the Final CCTS, the BEE – as the ICM administrator – will now be responsible for several functions with respect to CCCs as well (i.e., over and above its responsibilities related to ESCerts under PAT).

Such additional functions include those in connection with identifying (i) sectors, and (ii) the potential for reducing GHG emissions in such sectors, for the purpose of recommending those sector to the MoP for inclusion in the ICM. Further, the BEE will develop the trajectory and targets for entities under the compliance mechanism.

Further, the BEE will be responsible for CCC issuances pursuant to NSC recommendation and subsequent CG approval. In addition, the BEE's other tasks relate to: (a) developing a market stability mechanism for carbon credits; (b) developing the procedure for accreditation, as well as the functions of ACVs; (c) accrediting agencies pursuant to the approved procedure for ACVs; and (d) developing processes and conditions for the crediting period, renewals, and expiry in respect of CCCs. These apart, the BEE will develop data submission formats, undertake capacity-building activities, maintain the ICM's information technology ("IT") infrastructure, along with a secure database comprising CG-approved security protocols, etc.

Earlier, under the Draft CCTS, the BEE was also responsible for (1) developing standards, processes, and methodologies with respect to project registrations under the ICM's voluntary mechanism; and (2) issuing CCCs to both obligated and non-obligated entities, as recommended by the ICMGB. However, now that the Final CCTS has chosen to remain silent on the voluntary mechanism (as earlier proposed), such additional BEE functions have been removed from the scope of the scheme. Nevertheless, the BEE will constitute technical committees for different areas, as required under the compliance mechanism of the scheme.

The ICM

The ICM framework, as contemplated in the Final CCTS, involves a national framework established with an objective to reduce or remove or avoid GHG emissions from the Indian economy by pricing such emission through the trading of CCCs. In this regard, the Central Electricity Regulatory Commission ("CERC") – as referred to in Section 76(1) of the Electricity Act, 2003, as amended – will regulate all trading activities under the ICM.

Accordingly, the CERC will not only regulate matters relating to CCC trading, but will also safeguard the interest of both sellers and buyers, regulate the frequency of CCC trading, as well as provide market oversight and take necessary preventive/corrective actions to address fraud or mistrust.

Thus, from time to time, the CERC will approve the participation of electronic trading platforms – as defined under Regulation 2(1)(a) of the CERC (Power Market) Regulations, 2021, as amended (such electronic trading platforms, "Power Exchanges") – for the purpose of ICM trading. Accordingly, Power Exchanges need to seek the CERC's approval for their respective bylaws and rules for CCC trading on their platforms.

Other Bodies under the ICM

The Final CCTS authorizes the MoP to constitute the NSC. The NSC will remain responsible for ICM governance and directly oversee market functioning. It will comprise representatives from various ministries as its ex officio members, such as joint secretaries from those related to finance, steel, coal, new and renewable energy, as well as Niti Aayog, petroleum and natural gas, chemicals and fertilizers, agriculture and farmers' welfare, etc. – including, in particular, Secretaries from the MoP and the MoEFCC as ex-officio chairperson and co-chairperson, respectively; as well as the Director General of BEE as its member member secretary. The NSC will also include two expert members with knowledge in emissions, carbon trading, climate change, environment and energy, the chairperson of the CEA, along with the chairman and managing director of Grid Controller of India Limited ("GCIL").

In turn, the GCIL will act as the registry for the ICM. Among other things, GCIL is expected to discharge functions as determined by the MoP from time to time, including in respect of: (i) complying with the BEE's directions; (ii) undertaking registrations for both obligated and non-obligated entities; (iii) maintaining a secure database (with security protocols) and transaction records; (iv) sharing such records with the BEE and Power Exchanges; (v) assisting with the development of an IT platform for maintaining a CCC database; (vi) functioning as meta-registry for India, as well as establishing links with other national or international registries as approved by the CG.

As such, the role of the NSC within the ICM's power hierarchy is largely recommendatory – sitting somewhere between the BEE and the CG in terms of authority. For instance, the NSC is responsible for recommending procedures to the BEE for the purpose of further institutionalizing the ICM. In addition, the NSC has powers to recommend rules, regulations, GHG emission targets, guidelines about CCC trading and issuances, etc.

Earlier, under the Draft CCTS, the ICMGB – the erstwhile equivalent of the NSC – had the power to recommend methodologies to the CG, especially under the voluntary mechanism. Importantly, the ICMGB was also mandated to approve projects under the voluntary mechanism of the Draft CCTS, and could further recommend guidelines (for the CG's final consideration) with respect to CCC sales to entities/countries outside India.

Detailed Procedures

The NSC and other authorities will develop a detailed procedure for operationalizing the ICM pursuant to the Final CCTS.

Such detailed procedure will likely include: (i) the criteria for CCC issuances; (ii) the validity, along with floor and forbearance price, with respect to CCCs; (iii) the requirements, format, and timelines associated with submissions; (iv) monitoring, reporting, and verification; etc.

Conclusion

Given the short interval between the notifications of the Draft and Final CCTS, respectively, some reports suggest that India's scheme may have been expedited on account of the EU's Carbon Border Adjustment Mechanism ("CBAM"). CBAM is a mechanism through which the EU will impose a price (starting October this year) on the carbon emitted during the production of carbon-intensive goods that enter the EU from outside. The gradual introduction of the CBAM is aligned with the phase-out of the allocation of free allowances under the EU's Emissions Trading System ("ETS") to support the decarbonization of European industry. Since CBAM imposes unilateral carbon taxes on the EU's exporting partners, and given India's known concerns about CBAM, India's Final CCTS may have been rolled out as an equivalent of the EU's ETS for the purpose of allowing Indian importers to seek exemptions from additional carbon levies with respect to European exports.

This insight/article is intended only as a general discussion of issues and is not intended for any solicitation of work. It should not be regarded as legal advice and no legal or business decision should be based on its content.