This article is written by Megha Dalakoti of National Law University Orissa. The article has been edited by Smriti Katiyar (Associate, LawSikho).
India learned two important lessons in 1991 while performing a tectonic shift in its economic policies that triggered the end of a socialistic controlled approach and birthed the liberalised, free-market approach of the post-1991 Indian economy. The first is that businesses and restrictions cannot go hand in hand and the other is that the economic development of people is driven by investments that respond to monetary incentives over anything else.
These reforms are famously called the economic liberalisation of 1991 and are also known as the LPG (Liberalisation, Privatisation, and Globalisation) Model. Primarily, these reforms meant two major steps- ‘End of License Raj’ and ‘Incentivising Foreign Investment’, which are the off-springs of the two lessons mentioned above.
Years Later and in a totally different context, these two lessons again paved the way for a historic reform that transcended national boundaries and resulted in Article 17 of the Kyoto Protocol, signed in 1997 by the parties to the United Nations Framework Convention on Climate Change (UNFCCC), which envisaged the basic principles of ‘Trading of Certified Emission Reductions’, commonly known as carbon trading.
Carbon trading essentially means identifying and quantifying emissions of CO2 and other greenhouse gases and enabling the trading of certificates obtained by ensuring reductions in emission levels at domestic and international levels aimed at imposing a cost on emission-based industries while incentivising the ecologically sustainable technologies and industries to strike a balance between such industries and especially between developed and developing countries.
In the course of this article, we will discuss the necessity and introduction of carbon trading as a flexibility mechanism in the Kyoto Protocol along with the purposes served by it as visible from modern-day examples of benefits accrued and criticisms leveled at the carbon trading model, also including the legal shape of carbon trading in India.
Industrial revolution and anomalies in carbon and greenhouse gas emissions in developed and developing countries
In the late 1700s, major inventions like steam engines and mechanised factories, especially in weaving, led to an unprecedented spurt in the production of goods which consequently resulted in huge gains in per capita income of Britain and was later termed the industrial revolution. Britain, being at the helm of various colonies like India itself, had access to cheap, extorted raw materials and was the dreamland of inventions and technology in the early 1800s. Naturally, this made Britain the principal benefactor of the industrial revolution, followed closely by other European nations primarily due to their geographical proximity to Britain. At that time, apart from the European Nations, Japan and the United States were the only major non-European countries that gained from the industrial revolution. However, the majority, if not all, of Asiatic, African, and eastern countries were hung out to dry by those gaining at the expense of these colonized countries. The newfound technologies that enabled the processing of fossil fuels like coal, petroleum, and hydropower, started a rat race that had one objective- industrialisation and increased production in a bid to attain global supremacy. Subsequently, the two most important events in 20th-century history i.e., World Wars I and II further aggravated the push of global powers to engage in mass production of everything ranging from oil and food to weapons and automobiles. In the midst of these power battles or battles for survival, not one global power had the time to think about abstract but basic necessities such as air, water, climate, clouds, and existence-friendly temperatures.
However, as so often happens, the vision gets clearer as the dust settles, which in this case was the formation of the United Nations, aimed at resolving issues of international importance through peace, dialogue, and cooperation. Though the need of a discussion on conservation and utilisation of resources was identified as early as 1949 in the UN Scientific Conference (New York), and followed up in the Stockholm Conference held in 1972, also known as the First Earth Summit, the issue of climate change and global warming did not result in any concrete plan of action, but only in broader principles. However, the effects of global warming and the need to prevent climate change, caused by increased human economic activity across the globe, was a prominent feature of most discussions on challenges to the human race.
By the end of the 20th century, the world was a hugely divided place in terms of the economic and technological advancements of various countries. While those countries which had gained significantly during the early stages of the industrial revolution were already thriving, even the newly liberated or still developing countries had witnessed the tremendous potential of Industrialisation owing to the growing rates of global travel, international trade, and cultural exchange i.e., globalisation. This had instilled an urge to industrialise and attain self-sufficiency in these developing nations as well. Moreover, most of such nations had an abundance of natural and fossil resources waiting to be extracted. This led to a situation where on one hand, the developing nations were already thriving with functioning factories and near-optimum production levels which also meant successively higher emission rates with no sign of slowing down, whereas, on the other hand, the developing nations either already had plans or were making plans to increase the rate of industrialisation which meant that the existing lower levels of emissions were set to increase in such parts of the world as well.
As a result of this grave anomaly in economic development and distribution of wealth in the world, it was hard to strike a balance between the will to grow industry and trade (i.e., emissions) and the need to opt for sustainable methods of development which were slower, but more desirable. The developed countries deemed it too great an investment to shift the already installed machinery and technology towards non-emission-based or renewable technology, which was still developing and fairly expensive. On the other hand, any expectation of slower but sustainable development from the already looted or lagging developing countries was met with hostility seeing them as nothing but political connivance by developed countries to keep the fresher players at bay. This was also a reason for the failure, or relatively negligible success of the Stockholm Conference, as political agendas took precedence over addressing the issue of environmental protection and conservation.
‘UNFCCC’ and ‘Kyoto Protocol’
In the third Earth Summit held in Rio de Janeiro, Brazil in 1992, 154 member states of the United Nations Conference on Environment and Development signed the United Nations Framework Convention on Climate Change (UNFCCC). The UNFCCC then negotiated and finalised the Kyoto Protocol in 1997 which was the first concrete step towards identifying and quantifying emission rates and setting precise goals and guidelines towards reducing the emissions of greenhouse gases such as Carbon dioxide, Methane, Nitrous Oxide, Hydrofluorocarbons, etc. The Kyoto Protocol, though adopted in 1997, was not enforced before 2005, and adherence to the goals of reduction in carbon and greenhouse gas emissions was voluntary on the part of various nations. The Kyoto Protocol aimed at dividing the countries on the basis of their incomes and emissions in two groups i.e., Annex I and Annex II (Non-Annex I) countries. The developed or high income-high emission countries such as most European countries, United States, Australia, and Russia were listed as Annex I countries, and the low income, developing countries were listed as Annex II countries. While detailed guidelines and steps were listed in the Kyoto Protocol along with individual targets to countries in both these lists, Article 17 provided for emissions trading or carbon trading.
Before delving into the contents of Article 17 of the Kyoto Protocol, it is necessary to introduce one gentleman, Mr. Arthur Pigou, who as an economist proposed theories that later culminated in carbon pricing. Arthur Pigou was an English scholar and economist who first noticed that while various costs such as extraction and processing of fossils, transportation of finished products, and allied costs with consumption are included in the market prices of products of such fossils-based industries ranging from petroleum to air ticket prices to electricity, etc, there is no quantified cost of environmental damage caused in providing such goods and services to the end consumer. For example, while the cost of extraction of coal, transporting it to the thermal power plant, and generating electricity along with supply chain expenses and profits are included in determining the final price to be charged on the end consumer, there is no methodology in place to determine the cost of the air pollution caused by the burning of coal or the cost of cutting thousands of trees for the purposes of mining coal. Since that cost is not included in the cost price of the finished product, the market does not react to the damage being caused by heavy industrialisation at the expense of the environment and there is neither any cost for damaging the environment nor any incentive to refrain from it.
It was basically this proposal of determining the price of carbon emissions a.k.a. carbon pricing which laid the foundations for the measures suggested in the Kyoto Protocol which included determining the country-wise emissions and setting quantified and achievable targets to be met in the reduction of carbon emissions by the end of December 2020. While a host of nations have attained or exceeded the targets ratified in the Kyoto Protocol, the United States did not ratify the protocol and Canada withdrew from the same after the expiry of the first commitment period (2008-2012) in 2012. Though originally, Kyoto Protocol was to last till 2020, in 2016, it was superseded by the Paris Agreement within UNFCCC.
A bare perusal of Article 17 of the Kyoto Protocol leaves no element of doubt that the introduction of carbon trading was a supplemental measure and not the principal solution to eradicate all issues pertaining to carbon emission and global warming.
The necessity to introduce carbon trading as a flexibility mechanism
At this juncture, it is appropriate to refer to the two lessons learnt by India that resulted in the liberalisation of 1991 as mentioned in the introduction of this paper. As detailed earlier, the deadlock between the unwillingness of developed countries and developing countries, in shifting to an emission-free mode of industries and halting the industrialisation in the wait of cheaper and accessible emission-free technologies, respectively, meant that no uniform methodology could have been adopted to ensure that countries forfeit their short-term gains and patiently move towards sustainable development. This is where, the two lessons learnt by India prior to 1991 reforms become relevant, which are –
- Businesses and restrictions cannot go hand in hand.
- Economic development of people is driven by investments which respond to monetary incentives over anything else.
Since, prior to the Kyoto Protocol, the only tool widely used to curb high emission tendencies or to discourage high emission industries was carbon tax, there only existed a financial liability in going beyond a limit of emissions and absolutely no incentive for the usage of emission-free technologies. Further, complying with the tax proportions was much more feasible for established high emission industries to even consider switching towards low emission technologies as the cost to implement the same was significantly more than the carbon tax imposed generally. This was because the imposition of such a tax was a populist measure but no Government wanted industries to die out for mere eco-friendly appearances.
Further, non-rationalisation of taxes would have ultimately resulted in the eradication of industries which was highly undesirable. Even if imposed, if compliance with tax norms threatens the very existence of any industry, usually such liabilities are resolved by way of litigation or amicable settlements which resulted in an escape at lower sanctions. Since the nature of the Kyoto Protocol was voluntary, and the needs and challenges of countries and industries differed from one and another, the existence of a flexibility mechanism without resorting to extreme sanctions was necessary to achieve better compliance of the targets that were set out. Carbon trading as a flexibility mechanism, not only gave away to such industries which surpassed their limits of permissible emissions by purchasing CERs from other eco-friendly industries, but also enabled highly industrial countries to purchase CERs from the developing countries and stay compliant to the norms set out without being overburdened by extraneous financial liabilities which would have ultimately resulted in a breakaway from the Kyoto Protocol itself. The aim was to incentivise the emission-free industries without insisting on a total closure of high emission conventional industries wherein one such year, for any reason and by any quantity, the prescribed ceiling of emissions was surpassed.
The larger purposes served by carbon trading (in respect of developed and developing countries, emission based and emission eradicating technologies/industries/businesses)
Article 17 of the Kyoto Protocol, which required that all parties (member nations) shall define the relevant principles and rules for verification, reporting, and accountability for emissions trading, marked a shift from the carbon tax approach to the cap-and-trade approach. This meant that while acknowledging the reluctance of developed nations and the eagerness of developing nations, an arrangement was required to be made; which first fixed a maximum cap or ceiling of permissible emissions for all member nations but which could also provide flexibility in case such a cap was surpassed by way of trade. This was sought to be achieved in a two-fold manner: –
- Countries staying below their prescribed cap will gain “Certified Emission Reductions (CER).” Similarly, industries based on renewable or emission free technologies will also gain “Certified Emission Reductions”. For example, one ton of CO2 emitted equals one CER. Thus, one less ton CO2 emitted means gain of one CER while one more ton of CO2 emitted than prescribed limit by an industry, means that industry will need to buy one CER to stay compliant of the norms laid down. This created a financial incentive to go towards emission free technologies while also facilitating conventional industries to simply trade CERs if they exceeded their prescribed limits rather than face unnecessary sanctions or litigations.
- UNFCCC would also enable developed countries that are exceeding their prescribed limits to fund and implement projects in developing countries based around renewable and sustainable emission free technologies which ensured a necessary transfer of funds and technology to the developing nations. This enabled the developed nations or conventional industries to gain CERs by funding overseas projects and assisted developing countries in gaining access to newer technology which would otherwise have cost too much to import from such developed countries.
The two methods mentioned above are basically implementations of the two lessons i.e., finding a way to impose a cost on emissions without unreasonable restrictions, and at the same time, offering a monetary incentive to shifting towards greener, emission-free technologies. At present, carbon trading in itself is a multi-million-dollar industry that has managed to grow even during the great recession of 2007. This is solely because it offers flexibility to conventional industries in complying with the prescribed caps by enabling the trade of CERs and imposes costs in a manner that empowers low emission industries and provides the necessary funding and technology transfer. The second method of the undertaking and implementing projects in developing countries is mentioned under Article 12 of the Kyoto Protocol under the heading of clean development mechanism. India has been a major benefactor of the same and more than 20% of the total projects approved under this mechanism have been in India till 2014.
One of the best international examples of the benefits of carbon trading is that of Tesla Inc., electric cars, and a clean energy company. Another car manufacturer, Stellantis Cars announced in May 2021 that they will no longer purchase CERs from Tesla and rather look towards complying with emission norms by shifting to partially or fully electric vehicle models. Tesla Inc, being a clean energy company from day one, is said to lose a significant chunk out of the 518 million dollars that were earned through sales of CERs in the first quarter of 2021. This amounts to around 6 percent of total revenue earned by Tesla, but it is key to note here that this money is earned without having to manufacture any product to sell, but only because Tesla’s entire business is based on emission-free renewable technology. Further, if this income from carbon trading is excluded, Tesla would struggle to remain profitable consistently over a longer period of time. This single example encompasses the benefits of carbon trading in achieving both objectives i.e., of providing funds/profits to a renewable energy-based company initially and ultimately resulting in instigating another company to shift from conventional high emission trade to a renewable low emission trade.
Similar examples in India include that of Jindal Vijaynagar Steel which installed its steel plants with Corex Furnace Technology. This enabled the plant to emit 15 million tons less carbon and it is estimated that 225 million dollars can be earned through carbon trading of the aforesaid saved carbon in one decade. Rural areas of India have also benefited from carbon trading with companies engaged in business in Andhra Pradesh and Madhya Pradesh reported to have saved tons of carbons or restoration of forests resulting in additional income from carbon trading.
The major criticisms on the carbon trading model
Over the years, there has been multi-dimensional criticism of the Carbon Trading Model. Hardcore environmentalists argue that by proving a flexible mechanism of Carbon Trading, the necessity to strictly adhere to the prescribed limits has been done away with, which provides a back alley escape to repeat offenders. Their case is that, since no penal sanctions are there to be faced by countries and organisations violating the prescribed cap of carbon emissions, the cost factors involved in carbon trading are simply included in product price essentially being paid out of the pockets of the end consumer and not the industrialists or capitalists causing damage to the environment. It is further alleged that there are severe lacunas in the manner in which the price, quantity, and entitlement of CERs are computed and traded and even corrupt practices are not ruled out in overplaying or underplaying the emissions while determining CERs entitlement and liability to suit the needs of huge corporate giants enabling easy escape from any consequence of non-compliance. The lack of a competent and specialised agency, especially in developing or remote countries, to stringently deal with foul play and the still under-evolved legal framework further adds to the no-consequence scenario.
Cries for a total prohibition on highest emission industries are a common sight every now and then and there is little evidence to suggest that the insatiable lust of industrial growth can be prevented from demolishing any part of the environmental ecosystem that stands in the way of fulfilling this lust.
The legal position of carbon trading in India
Carbon trading or CER Trading in India happens on the commodities market of the country and at present are governed by the provisions of the Indian Contract Act, 1872 and Forward Contracts Regulation Act, 1952 due to the nature of the transaction which is that of forwarding contracts.
Acknowledging the need to further strengthen the Forward Markets Commission constituted under Section 3 of the Forward Contracts (Regulation) Act 1952, the Central Government also introduced the Forward Contracts (Regulation) Amendment Bill 2010, which is yet to be passed by the Parliament. After the enforcement of the Constitution (One Hundred and First Amendment) Act, 2016 and the introduction of the Good and Services Tax, a clarification has been issued by the Ministry of Finance vide its circular dated 01.03.2018 wherein the context of priority sector lending certificates it has been mentioned that PSLCs akin to freely tradeable duty scripts and renewable energy certificates are taxable as goods at the standard of 18%. CERs being similar to renewable energy certificates also fall within the same bracket.
In conclusion, it can be said, though not completely free of the scope of further improvement, carbon trading is a necessary measure to enable flexible operations and the positives far outweigh the negatives. Further, the negatives are not of such a nature that cannot be eliminated by way of introducing corrective measures. The problem lies in treating carbon trading as the panacea to all emission problems. Carbon trading essentially provides a stop-gap solution that enables industries and businesses to thrive while the world can shift towards sustainable technologies and businesses in a cost-effective and economically viable way. However, if no concrete steps are taken to realise the other more important goals of sustainable development, some of which find their place in the Paris Agreement, then mere reliance on carbon trading would render it useless in the long run. Examples like those of Tesla and Jindal Vijaynagar Steel clearly provide evidence that in circumstances where the stakeholders have acted with transparency and honesty, Carbon trading on its own has the potential to alter the balance sheets of companies and drag them from losses to profits.
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