Assessing Japan’s Emission Trading Trial Run

Japan’s nascent emission trading scheme

Participating companies in the trial totaled 501 at the December 12 deadline for the concentrated application period. Of these, 446 companies will set their own reduction targets, 50 will aim to trade emission credits, and five will reduce emissions based on the domestic credit system introduced by the Ministry of Economy, Trade and Industry in October 2008.

Companies that fall short of self-imposed targets can acquire excess credit from other companies and count it towards their own reductions. Participants who set goals for fiscal 2008 will submit progress reports by the end of August, and the results will be finalized in mid-October. As a result, active trading is not expected until after fall 2009. There will only be negotiated transaction for the foreseeable future, and trading houses and financial institutions are expected to mediate many of the transactions. The publishing of a price index, which would be referenced for buying and selling, is also under review.

In addition to trading emission credits, “Kyoto credit” and “domestic credit” can be used as methods to reach targets under the trial trading scheme. While Kyoto credit is based on the Kyoto Protocol (UN verified) and procured from overseas, domestic credit is a uniquely Japanese scheme. Under this framework, credit is generated by certifying the emission reduction achieved by projects of large corporations that provide funding and technology to domestic mid- and small-sized companies.

An effective scheme?

The goals of the trial run are: (1) clarifying system design issues and necessary conditions for the potential introduction of real emission trading; (2) exercising leadership in the formation of international rules that take into account systems suited to Japan’s industries. Priorities for the trial run system design were to make it easy for companies to participate and to verify the results of various cases, resulting in many options and a complicated scheme. This leaves doubt as to the effectiveness of the framework to adequately verify results.

To begin with, as it is a voluntary system with no penalties and targets are self-imposed, its ability to make real contributions to emission reduction is questionable. Entities that set targets can freely choose from participation at the business establishment level, individual company level, or corporate group level. Companies can “participate” in the manner most convenient to them. Moreover, participation at the industry group level, which in principle was not to be allowed, might be recognized. The Japan Iron and Steel Federation and the Japan Automobile Manufacturers Association have applied to participate at the industry level with a single reduction target. The reduction efforts of individual companies could become fuzzy depending on the targets and rules set within the industry group.

Companies participating in the Keidanren’s “Voluntary Action Plan on Environment” are expected to set targets consistent with this plan. As a result, unit base targets for emission per sales and production and total emission volume base targets will be mixed. This would make it difficult to evaluate reduction achievements, and could also impede active emission trading. Target setting, which will have a significant impact on the supply and demand of credits, is being entrusted to companies. The government will examine and confirm the appropriateness of targets, but doubt remains on whether the voluntary framework will function effectively.

At first the scheme will be limited to negotiated transaction, making it difficult to guarantee fairness and raising questions regarding the intermediary function of trading houses and financial institutions. The introduction of a real trading scheme should be accompanied by the establishment of a trading market. It is unclear whether emission trading would be active in the first place; if there are many participating companies but little actual trading, the trial would be rendered meaningless. In fact, the 446 companies participating in target-setting represent only a fifth of the 2,000 or so participants in the Keidanren’s “Voluntary Action Plan on Environment.”

Questions also remain on whether the trial run will help Japan exercise leadership in the formation of post-Kyoto international rules after 2013. Agreement on new international rules is expected at The 15th Conference of Parties to the United Nations Framework Convention on Climate Change (COP15) to be held in Copenhagen in December of this year. To have the achievements of Japan’s imminent emission trading reflected in international discussion, time constraints are more pressing than the content of such achievements.

How should companies respond?

Demands for low carbon management will undoubtedly become stronger in future. The trend of low carbon market development should be recognized as an important business climate. Following Europe’s framework, Australia, Canada and New Zealand have introduced their own emission trading schemes based on mandatory reductions, and a similar scheme is expected in the US under the new Obama Administration. Examination of international rules regarding the compatibility of the various emission trading schemes is also underway. In Japan, Tokyo City will introduce an independent emission trading scheme in combination with mandatory reductions for large scale business facilities in 2010.

The effectiveness of the trial run for domestic emission trading is indeed disputable. Recognizing the problems and limits of the scheme, and from the perspective of cultivating a business sense for carbon market value, companies should develop a conceptual framework for how to strategically take advantage of this domestic scheme and strengthen competitiveness towards the coming low carbon society.