Carbon markets

1. Economic rationale and basic concepts

Climate change involves a negative externality: producers and consumers do not normally bear the full social cost of their greenhouse-gas emissions. Carbon pricing seeks to internalise part of this cost. A carbon tax fixes a price per unit of emissions, while an emissions trading system creates tradable regulatory units. Under a conventional cap-and-trade system, the regulator limits covered emissions and issues allowances. Trading helps firms achieve the collective limit at lower cost because firms with cheaper abatement opportunities can reduce more and sell surplus allowances.

An allowance and a carbon credit are not identical. An allowance is a regulatory authorisation to emit a specified quantity, usually one tonne of carbon dioxide equivalent. A credit normally certifies a reduction or removal relative to a defined baseline. Credits may arise from methane capture, forest restoration or other eligible activities. Carbon dioxide equivalent permits comparison across greenhouse gases using global warming potentials; it does not imply that all gases have identical atmospheric lifetimes or physical effects.

An emissions trading system may allocate allowances free of charge, auction them, or combine these approaches. Scarcity, enforcement and expectations determine prices. Carbon markets can encourage cleaner investment and generate public revenue through auctions, but a weak cap or excessive credit supply can suppress prices. A market is therefore a policy instrument, not proof that emissions are necessarily falling.

• Absolute cap: limits total covered emissions during a specified period.
• Intensity target: limits emissions per unit of output; total emissions may still rise if production expands sufficiently.
• Offsetting: using an eligible credit to compensate for emissions elsewhere, rather than reducing those emissions directly.

2. Compliance markets, voluntary markets and credit integrity

Compliance markets arise from legal obligations. Regulated entities must surrender prescribed units or certificates against their emissions or performance shortfall. The European Union Emissions Trading System, operating since 2005, is a major cap-and-trade example. Voluntary markets serve buyers purchasing credits without an equivalent statutory surrender obligation, often for corporate climate claims. However, this distinction concerns the source of demand: a privately issued credit may become usable for compliance if a regulator expressly recognises it.

Environmental integrity depends on additionality: the credited mitigation should not have occurred without the incentive provided by the crediting activity. Baselines must credibly describe emissions in the absence of the project. Inflated baselines create credits without equivalent climate benefits. Monitoring, reporting and verification, commonly abbreviated as MRV, provide evidence, while registries track issuance, transfers and retirement. Retirement takes a credit out of circulation so it cannot be used repeatedly.

Other risks include leakage, where emissions shift outside the project boundary, and non-permanence, where stored carbon is later released through fire, logging or other disturbances. Forestry projects therefore require long-term safeguards, monitoring and mechanisms for addressing reversals. Double counting may involve duplicate issuance, repeated use or competing claims over the same mitigation outcome. Social safeguards are equally important: projects must respect land rights, local livelihoods and biodiversity. Purchasing credits should supplement, rather than substitute for, credible direct emission reductions.

• A verified activity is not automatically additional; both verification quality and the underlying methodology matter.
• Avoided emissions and carbon removals are distinct: preventing a release differs from withdrawing carbon dioxide from the atmosphere.
• Credit prices reflect methodology, perceived quality, delivery risk and demand; there is no single universal carbon price.

3. International climate governance: Kyoto to Paris

The Kyoto Protocol, adopted in 1997, introduced three flexibility mechanisms: international emissions trading, Joint Implementation and the Clean Development Mechanism. The CDM allowed eligible projects in developing countries to generate Certified Emission Reductions for use towards applicable Kyoto commitments. India hosted numerous CDM projects, including renewable-energy and industrial-efficiency activities. Criticism of additionality and uneven project distribution influenced later debates on market governance.

The Paris Agreement, adopted in 2015, places nationally determined contributions at the centre of climate action. Article 6.2 allows countries to cooperate using internationally transferred mitigation outcomes, or ITMOs, under accounting and reporting guidance. Where required, a corresponding adjustment changes the participating countries’ emissions accounting so that the same mitigation outcome is not counted towards both countries’ targets. It is an accounting operation, not a physical transfer of pollution.

Article 6.4 establishes a UN-supervised mechanism for generating credits from approved mitigation activities. It differs from Article 6.2, which accommodates decentralised cooperative approaches. Authorisation matters: not every Article 6.4 unit automatically receives the same international accounting treatment. Article 6.8, by contrast, provides for non-market approaches, including cooperation on finance, technology and capacity-building. Detailed Article 6 rules were agreed at Glasgow in 2021, while further decisions at COP29 in Baku in 2024 advanced operationalisation.

• The Paris Agreement does not impose one uniform global carbon market or carbon price.
• Article 6 cooperation should support higher ambition, environmental integrity and sustainable development, rather than merely enable cheaper claims.

4. India’s emerging carbon-market framework

The Energy Conservation (Amendment) Act, 2022 enabled a carbon credit trading scheme and the issuance of carbon credit certificates. The Central Government notified the Carbon Credit Trading Scheme in June 2023 and amended it in December 2023 to provide for an offset mechanism alongside the compliance mechanism. Together, these form the framework for the Indian Carbon Market. Notification of a framework must be distinguished from full implementation across every sector.

The Bureau of Energy Efficiency administers the scheme; Grid Controller of India Limited performs registry functions, and the Central Electricity Regulatory Commission regulates trading activities. The National Steering Committee for the Indian Carbon Market provides oversight and recommendations. Under the compliance mechanism, obligated entities face greenhouse-gas emission-intensity targets. Performance better than the applicable target can generate certificates, while a shortfall creates a requirement to acquire and surrender certificates according to the rules.

The offset mechanism enables eligible non-obligated entities to register projects and seek credits under approved methodologies. It does not mean every tree-planting or renewable-energy project automatically qualifies. India’s earlier Perform, Achieve and Trade scheme concerns energy efficiency and Energy Saving Certificates; Renewable Energy Certificates concern the renewable attribute of electricity. These instruments should not be treated as interchangeable with carbon credit certificates. Domestic issuance also does not automatically authorise international transfer under Article 6.

• The Green Credit Programme under the Environment (Protection) Act is a separate environmental initiative, not another name for the Carbon Credit Trading Scheme.
• Examination focus: identify the legal basis, responsible institutions, type of target and conditions for recognising or transferring units.

5. Benefits, limitations and policy priorities

Well-designed markets can direct capital towards lower-cost mitigation, encourage technological innovation and reward measurable improvements. Nevertheless, low prices, weak penalties, unreliable emissions data and policy uncertainty can undermine incentives. Free allocation may address competitiveness concerns but can also create windfall gains. Carbon leakage concerns arise when production relocates to jurisdictions with weaker climate constraints.

Equity requires attention to who bears compliance costs and who receives market revenues. Transparent auction-revenue use can support affected workers, cleaner public transport or vulnerable households. In project-based markets, meaningful community participation and benefit-sharing are necessary, particularly where forests and customary land rights are involved.

Effective governance combines progressively stronger targets, independent verification, transparent registries, enforceable penalties and careful rules for offsets. Markets must operate alongside renewable-energy deployment, efficiency standards, public investment and ecosystem protection. The central examination principle is that tradability reduces compliance costs only within the environmental boundaries established by law and credible accounting.

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