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Japan

Emissions Trading Moves Forward Regardless

Risaburo Nezu
Senior Executive Fellow

March 23, 2011 (Wednesday)

Emissions Trading Moves Forward Regardless

Many successes were realized at the COP16 assembly held in Eastern Mexico’s tourist spot, Cancun, during December, 2010. However, what was expected at first to be the greatest point of controversy, i.e. what will be the new international framework after the term of the Kyoto Protocol ends in 2012, was pushed off until COP17, which is to be held in South Africa. Japan, which dearly wants to avoid a simple extension of the Kyoto Protocol, seems to have achieved its goal for the time being.

Due to the outcome of the Cancun assembly, Japan has decided to shelve the issue of emissions trading, which is still under debate. Emissions trading, Feed-in Tariffs, and Environmental Tax together make up the three pillars of the Democratic Party’s environmental measures, and therefore, the fact that discussions of emissions trading have stalled is a big step backward for the government’s environmental efforts. This is clearly related to the fact that the Obama administration, which is very passionate about the environment, suffered a resounding loss in the mid-term election in November, and the bill which included emissions trading is now highly unlikely to pass congress. Japan seems to have a strong impression that emissions trading is now a unique system that only Europe is passionately promoting and that it will not become a global system, but in fact emissions trading has spread steadily at the local level.

1. The advance of emissions trading at the local level

The fact of the matter is, emissions trading is advancing in most of the world’s leading countries. Even setting aside the EU, which began emissions trading in 2005, North America and Australia have begun emissions trading at the state or provincial level, or are at least preparing to do so. According to the Financial Times of February 3, 23 of 50 states have implemented cap and trade or are preparing to do so, all the while looking askance at Capitol Hill, which has yet to begin moving. The first to move were ten of the Northeast states, including New York and Massachusetts、which implemented emissions trading back in January, 2009. This system, called RGGI, is aiming for a 10% reduction of power plants’ produced volume of CO2 by the year 2018. The state of California, on the US’s west coast, is preparing to begin an even more ambitious emissions trade in 2012. This plan, which covers 360 corporations and 600 places of business, will aim for a 17% reduction of 2012 emissions by the year 2020. California is considering a liaison with four Canadian provinces (British Columbia, Alberta, Ontario, and Québec) to create an emissions trade which crosses international borders, and in 2010 the first meeting for this trade was held. Apparently, the states which make up the majority of the US’s economic activity have already begun to implement emissions trading or plan to do so.

However, it is not only North America. According to the October 2010 report by the International Energy Agency, European countries which are not members of the EU, namely Norway and Switzerland, have implemented emissions trading. New Zealand began emissions trading in 2008; at first, the range of application included only forestry, but it has been widened to include power plants and other industrial sectors. Australia’s New South Wales began emissions trading in 2009, and while the process was slowed somewhat by the change of administrations in 2010, nation-wide introduction is planned for 2013. In light of this, one might say that there is no developed country in the world which shows no sign of beginning emissions trading. Japan is no different; in 2010, Tokyo implemented the first national plan to reduce emissions that was aimed at large corporations, and from April, 2011, emissions will be able to be bought and sold. Saitama will implement the same system from April and other municipalities are considering doing likewise. China, the largest producer of CO2 emissions in the world, is currently discussing the details of its 12th five years plan; one possible environmental measure it might take is emissions trading.

2. From top-down to bottom-up

In this way, while emissions trading is not advancing at the national level, it is steadily spreading at the local level. At international assemblies such as a COP, national interests are at stake in the negotiations and points of compromise are difficult to find, but individual regions see eye to eye more easily. Because the opinions of residents and industrial structures vary by region, it is most realistic to start with what is possible. This view of using a more bottom-up approach was prevalent in Cancun as well. The contents and details of the system also vary by region: some are limited to specific sectors such as power plants, while some are more comprehensive; some use an auction format for allocation of allowances, while some use free-of-charge allocation based on past performance. In some cases, the system is applied in parallel with other policy instruments, such as environmental tax. The aim, however, is always the same: to establish a market, make the price of emissions more “visible,” and make use of market mechanisms to lower the cost of emissions reduction.

3. Global emissions trading will happen eventually

It is highly likely that the framework for emissions trading will be established at the regional level before it is accepted at the governmental level at a COP. Hypothetically, if emissions trading markets were created in many areas or countries and the price of emissions were made more “visible,” what would happen then? Recently, it was reported in a case study that 1 ton of emissions was sold for \12,000 in Tokyo. If this information were widely disseminated, one after another, companies would say “In that case, let’s save energy and sell our emissions reductions too.” Conversely, companies that find it difficult to reduce emissions any further can buy them at market price. In this way, trades would increase and the market would grow. Just such a market is planned for Tokyo, and trading will start in April, 2011.

Once this type of movement begins to take hold around the world and the price of emissions is established in each market, people will start to combine markets next. In European markets, every day the price of emissions is set and posted just as oil and grain prices or currency exchange rates are. Sooner or later, the price of emissions will be set on the Tokyo market as well, but this price will most likely be significantly higher than those of other countries, particularly neighboring Asian countries. The reason for this is that Japan has already exhausted all ways of reducing emissions inexpensively, and further reductions will inevitably require higher costs. Consequently, domestic companies will think that since only Japan is being made to buy expensive emissions rights and is therefore at a disadvantage in terms of international competition, they should be allowed to obtain emissions rights from overseas. Furthermore, foreign countries will want to sell to Japan as well, because, from the perspective of reducing global warming, no matter where emissions are reduced, the effect is the same. For this reason, there are many who assert that what began as individual emissions markets should be linked together, thereby providing a globally uniform price for emissions and a fair system by which everyone can obtain emissions rights at the same price.

4. The stage is gradually being set

There is one very important condition for the establishment of such international emissions trading, and that is an agreement by all countries on a limit for emissions, as the name “Cap and Trade” suggests. Except for a number of developed countries, such as Japan and the EU, most have not yet committed to such a limit. In particular, China and the US, two of the biggest producers of emissions in the world, have made no such commitment, and so the system has yet to function at the international level. However, China has released goals in terms of specific carbon emissions consumption per GDP, based on which its limits can be calculated; it would appear that China is considering the introduction of emissions trading in its 12th five years plan, which begins in 2012. The US has many states which are already trading emissions, and it should be possible to link those markets to foreign ones.

One more condition is the careful inspection of emission amounts. In order to participate in emissions trading, we must be able to correctly understand a business entity’s emissions. In the past, developing countries have refused to allow international measuring, inspection, and reporting of emissions, but at the end of 2010, at the Cancun conference, these countries made an about-turn and will now allow such procedures, thus removing a large obstacle from the establishment of an emissions market.

5. The real reason behind anti-emissions trading sentiments: Japan’s environmental technologies will stop selling

While emissions trading is thus a very beneficial system for businesses, there are some industries in Japan that vehemently object. The various technological complexities of the system and the difficulty of its implication are given as reasons for this objection, but the real reason is something else entirely.

When the emissions trading market is established and the price of emissions becomes apparent, energy-saving technologies which are more expensive will lose their market. No business would go out of its way to reduce emissions at great cost to itself when it can buy emissions rights more cheaply. Japan has the most advanced energy-saving technology in the world, but further advances in energy saving would require the adoption of technology which costs more than $50 per ton of CO2 reduction. Meanwhile, there are many other countries which can save energy at much lower cost. For example, emissions are currently being sold in Europe for $15-20 per ton, and by some calculations, China may be able to sell emissions for as low as $3 per ton once it starts trading. Once emissions trading spreads throughout other countries, Japan’s technologies will be exposed as being too expensive, buyers will disappear, and with them any hope of recovering environmental investments made in the past. This is exactly what Japanese companies fear most. The problem of having excellent technology which does not sell because prices are too expensive is pervasive in all areas of Japanese industry, and environmental technology is no exception. In order to avoid such a situation, Japan prefers a bilateral credit scheme, which would attempt to increase exports of Japan’s environmental technology with public support from the Japanese government. This would be a very effective way of growing Japan’s technology market, but because the price of emissions is not publicly known, each country, each industry, and even each project has its own disparate emissions price. Therefore, not only does the optimal solution continue to elude us, but Japan’s emissions price remains high compared to those of other countries, and Japan’s entire economy continues to suffer losses.

6. Higher emissions prices are advantageous for Japan

However, even if each country established its own emissions market, integrating all those markets internationally would be far from easy. The bill that the US has prepared clearly prohibits trading of emissions outside the country, and China and India want to use emissions trading for the economic growth of their own countries, not for selling them over to foreign governments. Even if the international trading of emissions would be beneficial for its national economy as a whole, every country has the common idea that keeping the domestic price of emissions low would foster its industrial growth and reduce the burden on its consumers.

For a long time now, international institutions such as the OECD and the IEA have been calling for the creation of an international emissions trading system. For Japan—whose emissions prices will be relatively high—to drive sales of its environmental technologies in the overseas market, it would be beneficial if the global price of emissions were high. It is internationally recognized that heading toward 2050 much greater emissions reductions will be necessary, and the price of emissions will naturally rise as a result. The expected long-term rise in oil prices will also provide a tail-wind for environmental technologies. Japan must not try to swim against the current of international emissions trading, but rather, obtain the agreement of the other major powers to set high emissions reduction targets and thus increase the global price of CO2 emissions, thereby creating an environment in which Japan can demonstrate its technological competitive power.