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Reducing CO2 Emission by 25% is Feasible (Part 3)

“Strive for an East Asian Cap and Trade Framework”

Risaburo Nezu
Executive Fellow, Economic Research Center

March 01, 2010 (Monday)

Cap and trade and CDM are different

The 1997 Kyoto Protocol includes a framework called CDM (clean development mechanism) in which energy-saving ventures conducted overseas are considered as emission reduction in one’s own country. Japan plans to purchase a total of 400 million tons of emission by 2012 to achieve the Kyoto Protocol reduction targets. It will purchase most emission from China at 15 euros per ton for a total cost of nearly 1 trillion yen. CDM projects such as power generation, however, must be implemented in politically and economically unstable developing countries, and must be approved by international institutions. These projects are also expensive and user-unfriendly. The Japanese-funded tree-planting project is commendable, but rumors of a local company beginning new logging nearby have given the project a bad reputation among Japan’s industrial community.

Cap and trade is a far cry from this. Cap and trade frameworks will be established in all developed countries, and if these frameworks are linked Japan could buy cheap emission credit from Canada, Australia, and Eastern Europe and achieve 25% reduction at a significantly lower cost. Implementing special projects like CDM would be unnecessary. The current emission credit price in Europe is 15-30 euros, or a tenth of the cost of 25% reduction strictly in Japan. There are concerns that the price would soar from prolific Japanese buying. Yet, Japan emits only 4% of the global total, so the impact should be moderate. In addition, opportunities for cheap energy-saving in Russia and Eastern Europe suggest that supply of emission credits will increase. Most importantly, credit could be purchased under the same conditions as Europe, the US, and other developed countries and regions, resolving the problem raised by Japan’s industrial community that only Japanese companies would be forced to compete at a disadvantage.

Developing countries should also be called on to participate

International cap and trade could also spread to developing countries. To reduce global CO2 emissions, it is essential that that all governments, including those of developing countries, take responsibility for reducing their domestic emissions. The US was correct to insist on third-party verification at the Copenhagen summit. Countries suffering from air pollution, desertification, water shortages, and flooding tend to be in developing stages, and a rational burden structure would allow these countries to join global cap and trade. Stories of massive steam leaks from holes in dilapidated power plant boilers and flames spilling out of furnace cracks are commonplace in developing countries. Simply sealing such cracks and holes could achieve significant reduction at nearly no cost, and this reduction could be sold on the market. In other words, it would be an attractive opportunity to gain a new export industry for developing countries. These countries, however, would have to join an international framework with measurable individual commitments as a prerequisite. Trading with uncommitted countries would not work because verifying their reductions would be impossible.

Promoting as a specific and concerted East Asian framework

East Asian countries evidently perceive Japan as a “good customer” for emission credit. If so, Japan should fully exercise its power as a customer. Actually, the US and EU will buy significantly more if an international framework is established. Japan should convince the US and EU to join it in an international framework, a proposal that should garner serious consideration. Japan was unable to fulfill its clear role at COP15 because it focused solely on its own reductions and financial support while failing to offer a specific proposal for an international framework. Many Asian countries will start to see a surge in emissions. Cap and trade that includes these countries will greatly facilitate global warming negotiations. Refusing to buy credit from countries outside of the framework will create an incentive for these countries to join. Fortunately Asian countries such as Australia and New Zealand are already implementing cap and trade; there should be room for cooperation with these countries.

The EU, US, and Japan currently set their reduction targets independently, meaning fairness cannot be ensured. Is there a way to objectively decide emission amounts for each country? One idea is to allocate emission proportionally to current GDP size, but developing countries are likely to reject this as unfair. I endorse the concept of allocating according to population. This would put Japan and other developed countries at a disadvantage with low allocations. In contrast, heavily-populated countries such as India would receive relatively high allocations, possibly higher than currently necessary. This will provide an incentive for developing countries to participate in an international framework. A “hot air” problem of being able to export emission without any reduction efforts would emerge in this scenario. Yet, global emission would be decreased ahead of the 2020 and 2050 targets and “hot air” countries would receive smaller allocations, resolving the problem in a short period of time. For developing countries, it should be an appealing opportunity to gain a new export industry with low-cost reductions. Japan should promote this scheme as a specific and concerted effort of East Asian countries.

Sectoral approach made possible by linking to cap and trade

The sectoral approach attempts to reduce global CO2 emission by shifting new technology to industries in lagging developing countries for improving energy efficiency in steel, electricity, cement, paper pulp, and so on. The APEC region has formed task forces in all major sectors and has advanced technological studies since 2005. This move was initiated by the US, which wanted to avoid a negative image from refusing to join the Kyoto Protocol. Japan quickly supported the idea as it was consistent with the industrial community’s wishes. Discussion on the sectoral approach, however, has been limited to technological studies, and specifics such as who will transfer what kind of technology to whom and under what timeframe are unclear. Moreover, discussion on the most important issue—who will shoulder the costs—has yet to begin. The Obama Administration has since steered discussion towards cap and trade as its enthusiasm for the sectoral approach has waned.

Supporting developing countries through auction revenue

The sectoral approach is limited in that it can only cover some sectors, and is flawed in that fairness cannot be ensured among the sectors and imbalances in energy-saving can emerge. This approach, barely discussed at the Copenhagen summit, therefore cannot replace general policy such as cap and trade and environmental tax. Energy-saving technology transfer is preferable in certain sectors such as steel, and complementary use in tandem with cap trade would increase effectiveness. In particular, funding for technology transfer could be secured through revenue from emission credit auctions.

Avoiding overlap with environmental tax

Environmental tax is similar to cap and trade in that its goal is to reduce emission through the market mechanism. Environmental tax, however, is flawed: the amount of reduction cannot be measured beforehand. Establishing both frameworks would create a double-regulation and is questionable from a policy perspective, a point that demands careful consideration as Japan begins serious discussion on environmental tax. The EU has adopted both cap and trade and environmental tax, but this is because it allocates most emission for free. Across-the-board implementation of auctions in the future would likely phase out environmental tax. From the government’s perspective, while revenue from environmental tax would be replaced with revenue from selling emission credit, cap and trade should cost less overall so government income would decrease. Perhaps this inconvenience to financial authorities is why the government prefers environmental tax.

Japan should aggressively reduce crude oil and coal consumption

The prevailing thought in Japan is that domestic reductions should be minimal. Of course, this feeling is shared elsewhere: the Copenhagen summit was a struggle of how to minimize one’s own reductions while maximizing the burden of others. Looking to the future, however, Japan would benefit from a structural shift to an economy as independent from oil and coal as possible. The IEA predicts that at the current rate oil will reach US$200 a barrel in 2030. Japan imported 14 trillion yen of oil in 2008, a figure that will rise to 28 trillion yen by 2030 absent a reduction in imports. Meanwhile, Japan’s exports are in long-term decline, a trend that is likely to continue given the shift of industry overseas and increasing competition from Asian companies. This means that maintaining oil imports at the current level is impossible in terms of the balance of payments. The US struggles with its balance of payments and with maintaining the dollar’s exchange rate because it has neglected energy-saving and let oil imports steadily grow. Energy-saving and use of new energies are critical to the future of the Japanese economy.