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11 Aug 2023 | 05:45 UTC
Highlights
ETS price expected to start low and increase gradually
Govt-backed JCM likely to face lesser political risk compared to VCM
Cross-border carbon taxes may put pressure on Japan to price carbon
Japan lacks both a sense of urgency regarding climate change and the political will to advance carbon pricing mechanisms that would impose a cost on its emission intensive industries, Patrick Burgi, managing director of Japan with South Pole, said in a recent interview.
Japan, the world's third-largest economy and the fifth-largest emitter of CO2, has been lagging the European Union in deploying an expansive carbon pricing regime despite being one of the most developed economies in Asia-Pacific.
Its national compliance emission trading scheme or ETS, called the GX League, started operations this year and will remain voluntary for companies up to at least 2026. The scheme's emission reduction targets are also set voluntarily by companies instead of the government.
"One thing that worries me a little bit in Japan is the sense of urgency among the population. That can change very fast, but right now, I feel that politically the topic [climate change] is less urgent than it is in Europe. And that will transfer into the carbon price," Burgi said.
"For the GX League pricing, my expectation is that it will start small and then increase over time, but it would only reach the same levels as in Europe if the topic gains importance politically," he added.
Platts, part of S&P Global Commodity Insights, assessed the nearest-December's EU Emission Allowance at Eur84.9/mtCO2e ($93.26/mtCO2e) on Aug. 10.
Companies who have signed up under the GX League can use two types of credits to offset their emissions – J-credits generated domestically, and JCM (Joint Crediting Mechanism) credits generated from projects in other countries but financed by Japan, in line with the Paris Agreement's Article 6.2.
"If you look at both J-credits and JCM, the volumes issued historically were very small. That's something that worries everyone in the market. And that's something very important for South Pole [to address]," Burgi said.
"We see a lot of interest from companies to start looking into both JCM and J-Credits," he said. "The demand is not very big because the targets are quite soft and it's all voluntary, but everyone wants to learn and wants to prepare for the time after 2026 in case the targets become stricter."
"For JCM in particular, from the moment you identify a project, to getting the units issued, it may take two or three years or even more, so they need to prepare early," he explained.
While the UN's Article 6.2 framework has no specific rules governing private sector participation, the JCM has evolved from an inter-governmental scheme to include the private-sector – a move into unchartered waters that only a few other countries like Singapore and Switzerland have attempted.
"This [private-sector JCM] also motivates South Pole to become more active and bring a pipeline of projects to Japan," Burgi said, adding that the company is looking at both supply-side projects as well as helping Japanese companies source JCM credits on the demand side.
How the carbon credits will be split between project host country and Japan is open for negotiation, he added. "It follows the logic of how much of the costs and how much of the risks is borne by the Japanese entities who want the credits."
"If the whole project is 100% financed by foreign capital from Japan, and the Japanese companies are taking all the risks, I think it will be fair to assign more credits to the Japanese side," he said. "But obviously the host country has some leverage. If they say 'well, without my approval, you don't get anything', there's always a negotiation process."
Burgi said JCM credits have more political certainty than voluntary carbon market or VCM credits despite the longer gestation period needed for the projects, especially with many host countries halting VCM credit exports in recent months.
However, Japanese industries are also having to contend with pressure from a growing trend of cross-border carbon taxes such as EU's Carbon Border Adjustment Mechanism, or CBAM.
Burgi said if European car manufacturers under the EU ETS have to pay Eur100/mtCO2e for offsetting their carbon footprint, Japanese car manufacturers who don't incur a carbon cost enjoy a price advantage.
"I think it will be just a matter of time until Europe starts expanding CBAM to such products as well," he said, adding that such taxes could push Japan to take more action on climate change.
But CBAM could also impact trade flows for commodities like iron and steel that are raw materials for Japan's manufacturing industries, and similar to what happened to oil and gas after the Russia-Ukraine war, volumes rejected by Europe could be picked up by countries like India and China, or even Japan.
"A global carbon price would always be preferable to such regional carbon pricing initiatives," he said, but added that so far a global carbon price has been out of reach.