Developing Projects Under Voluntary Carbon Market in Nepal: Opportunities and Challenges

The Emergence of Carbon Credit

The last decade, 2011-2020 was the warmest on record which saw the worst of mankind’s suffering from the effects of climate change. Millions has been displaced due to the climate change induced natural calamities around the globe. To tackle these climate concerns, 195 countries have committed reduced greenhouse emissions under the Paris Agreement 2015. In this context, carbon trading serves as a major instrument for reducing carbon emissions.

The concept of carbon trading originated under the Kyoto Protocol, intended to cap permissible emissions allowed in developed countries and trade off emissions beyond the prescribed limits through transitional energy mechanisms that either reduce, store, or offset the excess quantity of emissions. This approach later became the basis for US, UK, EU and other 27 countries, to establish a compliance carbon market.

In parallel with the Compliance Carbon Market, voluntary investments began to fund carbon emission reduction projects, with early investments in the first REDD (i.e., Reducing Emissions from Deforestation and Forest Degradation in Developing Countries) projects in Belize and Bolivia. This eventually led to the creation of a separate market for carbon trading, known as the Voluntary Carbon Market (“VCM”). Although still in its nascent stage, the voluntary carbon market has seen a total of 2.4 billion metric tons of carbon emission reduced, with generated revenue of USD 10.8 billion dollars from 2005 to 2023. It is expected that carbon trading should have investments of USD 536 billion by 2050 to reach the target of net-zero emissions.

There are plenty of opportunities for Nepal to capitalize on the VCM. VCM could be key financing tool for Nepal to support clean energy and transition to green economy.

Understanding the Status and Future Prospects of VCM in Nepal

There are only a few carbon trading projects currently operating in Nepal under VCM which is largely dominated by improved cookstove and Nepal Biogas Support Programs. Nepal’s status in the VCM is negligible compared to other countries around the world. To give an illustration, Bangladesh holds a 24% market in the VCM amongst the least developed countries, whereas Nepal only holds a 5% project portfolio.

There are many unexplored sectors in Nepal for carbon trading under VCMs. For instance, an UNDP Report suggests there is a lot of prospects for Nepal to engage in Agriculture, Forests, and Other Land Use (AFOLU Sector). This includes Methane emission reduction from feedstock improvement in dairy cattle, Substitution of Nitrogen fertilizers by rhizobacteria inoculant, Methane emission reduction by adjusted water management practices in rice cultivation.

One of the key reasons for Nepal falling behind in the VCM sector is the lack of private sector participation. Private sectors can act as a proper driver in the market with respect to investment, diverse project portfolio, competitive market sentiment and professional engagement of domestic and foreign stakeholders to build and operate carbon trading projects. However, there are various legal and regulatory constraints that hinder private sectors entry into the carbon market.

Addressing the Barriers for Private Sectors in VCM Development Projects

The existing laws of Nepal have not provided clear mechanism to facilitate carbon trading under the VCM in Nepal. Currently, carbon trading is recognized under Environment Protection Rules 2077(2020) (EPR). However, Rule 28 of the Environment Protection Rules (EPR) is still limited to recognizing carbon trading projects under the framework of the Kyoto Protocol, which largely became ineffective after its expiry in 2020.

The Ministry of Forest and Environment took four years to publish a draft amendment of the EPR and align the provisions of Rule 28 with the Paris Agreement. It was anticipated that the amendment bill would clearly outline provisions that would encourage private sectors to engage in the VCM. However, the amendment bill has brought more fear than hope to the EPR. The amendment bill includes provisions for extremely rigid legal compliance for private developers of operate carbon trading projects. Here are some of the key provisions that have created immense worry amongst the private sectors engaged in the VCM:

1. Recognition of Carbon Trading Mechanism:
   The amendment bill recognizes the ability of private sector to participate in carbon trading under both the framework of the Paris Agreement and the VCM. However, the provision places a permanent risk on the private sector’s ability to independently engaged in the VCM. This is because the amendment bill grants the government the authority to endorse all carbon projects. Under this provision, the government can at all times justify the appropriation of carbon credits and deprive private sectors to trade the carbon credits without the interference or the government’s right to apportion the project.
2. Ministry of Forest and Environment as Designated National Authority
   The Ministry has been given regulatory authority and sole discretion to determine permissible and impermissible sectors for conducting carbon trading in Nepal. While such restrictions are provided to ensure that the Government prioritizes its opportunity and carbon reduction emission targets under the Nationally Determined Contributions (“NDCs”), the Ministry’s broad discretion may even supersede the reasonable interest to meet the NDCs targets. This puts the carbon trading projects of private sector at a greater risk of arbitrarily being denied permission to trade carbon credits in the future.
3. High Threshold for Revenue Sharing Model
   The EPR mentions the project developer to be provided with 80% of the carbon trading benefit to the beneficiary of the project. The provision does not clarify the meaning of “benefit” and “beneficiary”, which makes the cost of revenue sharing model uncertain. Additionally, the project developer is required to pay certain fees and royalty at various stages of the project, consequently increasing the cost of the project.
   The private sector is seriously concerned about the requirement for high revenue sharing model placed in the amendment bill. It may be reasonable for the government to assume that private sectors can operate under such a high revenue-sharing model because there are various projects under forest activities and projects operated by AEPC that follow 80% revenue-sharing model. However, these projects are not operated solely with the motive to generate profit and are mostly supported by grants and backed by government. The same revenue-sharing model is not feasible for all projects developed by the private sector.
   According to a private developer of carbon projects, executing a project under 80% revenue-sharing model would only generate about 2% of Internal Rate of Return (“IRR”) from the project, whereas the normal saving interest rate provided by commercials banks goes up to 3-4%. The project developer cannot develop bankable projects under this model.
4. Provision for corresponding adjustment
   The EPR provides for corresponding adjustments for projects trading their carbon credits in the international market. The project company can make an application to the Ministry for sale of carbon credits upon which, the ministry accounts 10% carbon credits derived from the project under the NDCs and records the remaining carbon credits for the project company to trade internationally. However, the requirement to account 10% carbon credit in NDC for corresponding adjustment increases the additional cost on the project. Globally, states have required a 5% of carbon credit for corresponding adjustment. It is essential that the Ministry maintains a balance between fulfilling its commitments under the NDC and at the same time, maintaining reasonable treatment to developers of carbon trading projects.

While it is encouraging that the government intends to recognize the need for the private sector in the VCMs, the amendment bill creates additional challenges rather than facilitating the growth of VCM.

Additionally, there are other pending regulatory issues which require reform to support the VCM. One of the major problems is that the carbon trading has not yet been recognized under the category of permissible industries under the Industrial Enterprise Act 2076 (2020). In this context, the potential fear within the private sector engaged in VCM over its legal status to invest and engage in the business remain intact.

Thus, the Government should promptly take the initiative to resolve the pending issues and facilitate private sector from both domestic and foreign markets in carbon trading. Opportunities in current carbon market needs are like fleeting moments – Timely policies, favorable treatment for the stakeholders, and economic reforms should fuel its strength. But if Nepal fails in capitalizing on these opportunities over the next few years that the potential success of the market may be gone forever.