The rapid progress of carbon pricing in Indonesia has reached important milestones. Presidential Regulation (Perpres) 98/2021 on the Carbon Economic Value, or Nilai Ekonomi Karbon (NEK), has served as the cornerstone for building the infrastructure and framework for its implementation. The birth of the NEK regulation is a response to the Article 6 Paris Agreement, which allows parties to trade carbon in order to lower emissions. Some instruments are offered under the regulation, consisting of carbon trading, result-based payment, and carbon tax, which was twice delayed and is expected to be launched in 2025. Among all the instruments, carbon trading is identified as a mature instrument with a cap-and-trade mechanism that enables institutions to claim their high-intensive emission by buying credits from other activities that provide carbon stocks.

To strengthen the implementation of carbon trading under Law 4/2023 on the Development and Strengthening of the Financial Sector, the Financial Services Authority (OJK) is tasked with establishing and overseeing carbon trading in the carbon market. In just 7 months, the OJK issued regulations on carbon trading through carbon exchanges and officially launched the carbon market on September 26, 2023. This means that financing is one of the solutions to bridge the gap in achieving climate targets and plays a crucial role in raising awareness of the devastation of climate change, especially for the business sector.

Prior to this, Indonesia has been familiar with the Voluntary Carbon Market (VCM) since the past few decades before deciding to establish a mandatory carbon market to meet Nationally Determined Contribution (NDC) targets for specific sectors. For example, the Sumatera Merang Peatland projects has successfully sold 3 million carbon credits to big companies and the Indonesia Climate Exchange (ICX), a trading platform, was created to build an ecosystem for the private sector with the voluntary scheme.

Earlier this year, power generation was chosen as the first subsector to implement mandatory carbon trading due to its easily identifiable emissions calculations, based on and strengthened by the Ministry of Energy and Mineral Resources Regulation 16/2022 on Procedures for Implementing Carbon Economic Value in the Power Generation Subsector. This was initiated in a pilot program in 2021 before being launched in February 2023.

In the first compliance carbon trading phase, 99 CFPP which covers 86% of coal power plants in Indonesia participating in cap and trade schemes. Each CFPP has a maximum allowance or emission quota that is set based on the previous performance and unit criteria. For those who emit less than the allowance, they are able to trade the remaining quota to other companies that exceed the maximum cap. When the CFPP emission is above the given quota, they must reduce the emission by buying quota from other CFPP or purchase carbon credits.

The success of this pilot program, while requiring some improvements, has encouraged other sectors to consider carbon trading and expand its implementation beyond the energy sector, pending the release of the carbon trading roadmap currently under discussion at the Coordinating Ministry of Investment and Maritime Affairs.

With the establishment of the carbon market, the trading products to be sold and traded are carbon quotas from the compliant sector, called PTBAE-PU, and carbon credits, or SPE-GRK. PTBAE-PU could only be sold and bought by the mandatory sector that has the maximum cap on emitting emissions, while credits may be supplied from various projects, for instance peat restoration and renewable energy projects, where all participants are able to purchase the credits to avoid the emission.

To participate in the carbon exchange, all entities, whether producers of emissions or not, must obtain a permit from the National Standard Registry (SRN), a platform managed by the Ministry of Environment and Forestry as a national database for emissions and validate credibility of products and participants involved in the carbon exchange. With high hopes, careful emission monitoring and evaluation could be easily integrated across sectors in one platform and increase accountability and data transparency that is being shown to the public.

The launch of the carbon exchange just one month after the OJK issued its regulations has raised several questions, one of which is whether Indonesia is adequately prepared to manage it. In the absence of a comprehensive market ecosystem, careful planning and implementation by the government, particularly the regulator and relevant ministries, is needed. Although enthusiasm has been shown by 13 transactions with a total volume of 459,914 metric tons of CO2 equivalent at a unit price of around USD 4.51, dominated by state-owned enterprises on the first day of the launch, lessons from several emissions trading systems (ETS), such as China’s, show that it takes a considerable amount of time, almost a decade, to build a strong and mature market ecosystem. Validation, credibility, and data transparency are fundamental aspects that should be carefully monitored by various stakeholders, including the OJK, the Ministry of Environment and Forestry, the Ministry of Energy and Mineral Resources, and others. Market integration between power sector carbon trading and the upcoming compliance sector with the recently released carbon market must be implemented to achieve one common system and pricing mechanism, since voluntary parties dominate the current market.

The existence of a carbon market provides an opportunity for companies to raise finance through carbon trading within the market. However, this should be closely scrutinized in terms of the requirements for companies to enter the market, such as taking action to reduce emissions, maintaining comprehensive emissions inventories, and having strategies for future emissions reductions. It is important to avoid the interpretation that the carbon market is simply a strategy to reduce emissions by buying as many carbon credits as possible. There should be an institution capable of conducting accurate and comprehensive checks and verifications of the PTBAE and SPE-GRK being traded, as well as verifying valid and internationally recognized calculation methodologies to avoid double counting and ensure accountability for projects generating PTBAE and SPE-GRK. In addition, there should be a careful monitoring system of the use of carbon market funds. The government has mentioned that the funds will be managed by the Environmental Funds Agency (BPDLH), but it is not clearly stated how the mechanism works yet.

Renowned for its tropical forests and abundant renewable energy potential, most of Indonesia’s carbon credits come from natural resources. Indonesia’s FOLU sector could potentially absorb 25.18 billion tons of carbon from rainforests, mangrove conservation could absorb around 33 billion tons of carbon, and peatland could absorb almost 55 billion tons of carbon. With the advent of the carbon market, significant forest, mangrove, and renewable energy projects are expected to grow rapidly. It is crucial to assess and verify each project holistically and monitor its implementation to avoid ‘greenwashing’ practices that claim significant carbon sequestration and reduction without following established procedures.

It is also important to maintain a balance between supply and demand in the market in order to maintain market enthusiasm and ensure smooth transactions. Given the early experience of the European Union Emissions Trading Scheme (EU ETS), where an oversupply led to carbon prices approaching zero in 2007, precautions should be taken to prevent carbon prices from becoming uncompetitive. In addition, the carbon market will soon allow companies outside Indonesia to participate in carbon trading, which could lead to carbon leakage if prices are not competitive and domestic companies do not benefit from the incentives provided by the carbon market.

The Ministry of Energy and Mineral Resources (ESDM), which regulates quotas and allowances in the electricity sector, must limit the emissions allowed by each company that owns power plants. With a planned maximum quota of 85% in 2024, it is expected to encourage each operator to develop emission reduction strategies. At present, quotas are still based on emission intensity and the average emissions of the previous year, which can lead to higher allocations in the following year. Regular monitoring is therefore required to reduce the emission quotas for each power plant.

Carbon markets also open the opportunity to widely inform the green taxonomy principles, especially to financial institutions, investors, and project owners. It could enable the identification of whether a project can be traded in the carbon market and falls within the green taxonomy classification. This can enhance transparency in assessments and trust while assisting investors and financial institutions in mobilizing funding for sustainable projects. However, further institutional coordination and agreements are also necessary for this.

Although the carbon market in Indonesia is still relatively new, its effective implementation is expected to drive changes in industrial behavior, particularly in the power generation sub-sector and the energy sector as a whole. Information dissemination to a wider audience is important to attract more buyers and traders to participate in carbon exchange beyond energy sectors. In this nascent stage, an incentive from the government is required since to pass the ‘green’ criteria, extra processes are needed which creates additional cost and potentially becomes a burden, making the carbon market unattractive. The market also creates opportunities for Indonesia to fulfill the need of climate financing, while pushing the launch of carbon tax is important as the complement tool. Regular monitoring and evaluation is necessary to keep all the activities on the right track while further enhancements and developments are necessary to make the market eligible at the international level.