Carbon markets expand worldwide but will they deliver meaningful emission reductions?

• • Countries implement around 80 carbon pricing instruments globally

• • CBAM, border carbon taxes triggering ETS adoption in key economies

• • Minus an absolute cap, will Indias CCTS help lower CO2 emissions?

Morning Brief: Carbon pricing has emerged as a key policy tool for governments worldwide not only to channel finance towards decarbonisation efforts but also to facilitate structural changes in the economy and ensure broader social and environmental goals. However, recent research shows that trade tensions and border carbon taxes are also pushing more and more countries to adopt internal emission trading schemes (ETSs) or direct carbon taxes to counter the impact of levies and liabilities accruing from foreign trade.

The World Bank’s latest State and Trends of Carbon Pricing’ report states that carbon pricing now covers around 28% of global GHG emissions, which is around 15 billion tonnes of CO2 equivalent (bntCO2e) out of total global emissions of over 52 bnt. There are now 80 direct carbon pricing instruments in operation around the world, with 43 of them being carbon taxes and 37 ETSs.

“Jurisdictions comprising almost two-thirds of global GDP have a direct carbon price in place and the largest middle-income economies, including Brazil, China, India, Indonesia, and Trkiye have implemented or are moving toward implementing carbon pricing,” the report notes.

CBAM & BCAs:

Incidentally, the middle income economies are the ones most severely impacted by the EUs Carbon Border Adjustment Mechanism (CBAM), and several other countries have taken up the EUs lead in pursuing some kind of a border carbon adjustment mechanism (BCA). “The introduction of BCAs is motivating countries to implement carbon pricing and to prioritise carbon pricing in sectors covered by planned BCAs,” notes the World Bank report.

For example, Trkiye’s Medium-Term Program (20232025) ties the planned national ETS to the EU CBAM. Israel’s decision to adopt a carbon tax cites the need to support facilities exposed to international trade. Malaysia is considering a potential carbon tax on industry to create a level playing field for domestic producers in sync with the EU CBAM. Vietnam is moving towards implementing its own ETS for CBAM sectors. Chinas national ETS coverage expansion has prioritised sectors covered by the CBAM.

A domestic carbon price can reduce exposure to BCAs in primarily two ways:

1. By incentivising improvements in the production efficiency of exported goods

2. By reducing import charges by demonstrating that a carbon price has already been applied

CCTS: Between ambitions and reality:

In July 2024 the Indian government adopted detailed regulations for its planned Carbon Credit Trading Scheme (CCTS), a rate-based ETS covering an initial nine energy-intensive industrial sectors. Empirical research has demonstrated that rate-based carbon pricing systems as opposed to ‘cap and trade’ systems allow more flexibility to governments to manage economic productivity and economic outcomes.

A rate-based approach is being used in Australia, Canada, China, and Indonesia. Chinas national rate-based carbon trading system determines emissions limits based on the technology used by entities. The system is designed to avoid excessively penalizing companies that rely on older technologies, which are often located in poorer regions, observes the World Bank report.

In India’s case, the CCTS diverges from the erstwhile PAT scheme. In the steel sector, the government has identified technologies for the next six years. Based on those technologies, the Bureau of Energy Efficiency (BEE) has calculated the investments required and the marginal abatement cost, which is the amount needed to be invested to save one tonne of CO2. Companies are assigned an energy-related GHG emission intensity target and earn tradable certificates if they exceed them.

However, as the WB report notes: “If benchmarks are differentiated by technology or fuel type (in the case of rate-based ETS), it can be harder for clean firms to compete, since their less-efficient competitors receive higher baseline allocations per unit of the same product.”

Finally, India’s CCTS, which will come into force this year, doesn’t follow a cap-and-trade system and so doesn’t mandate an absolute level of reduction in emissions, rather setting out emission intensity reduction targets for the designated entities in key sectors. The absence of a cap means the level of emissions reductions delivered by a rate-based ETS is less certain than a cap-and-trade.

Notably, objections have already been raised against the low level of ambition reflected in emission reduction targets underlined by the BEE for designated entities under the CCTS. This low ambition level can adversely impact the carbon price and, most significantly, undermine efforts to meaningfully deal with burgeoning emissions.