Carbon pricing: Applying the EU's experience to Japan's policies

Consulting Fellow, RIETI

On January 27, 2022, the Research Institute Economy, Trade and Industry (RIETI), The Institute of Energy Economics, Japan (IEEJ) and EU-Japan Centre for Industrial Cooperation (EUCJ) co-hosted a webinar titled "Carbon Pricing for Net Zero / Utilizing Market Mechanism."

In June 2021, the EUJC and RIETI co-hosted a webinar in which experts from Japan and Europe discussed industrial and policy issues related to carbon neutrality, which received a lot of positive feedback (Click here for information about the RIETI-EUJC Joint Seminar).

This year's conference was co-hosted jointly by the three organizations including the IEEJ and featured experts and specialists from both the EU and Japan who introduced their respective approaches / positions toward carbon pricing and market mechanisms, which are also attracting attention in Japan as methods to achieve net zero. In particular, based on the experience of the EU, we explored lessons for Japan, which is expected to introduce such mechanisms in the future.

Carbon pricing mainly includes carbon taxes and emissions trading systems. On this occasion, the discussion focused on the EU Emissions Trading System (EU-ETS), the current status of the Carbon Border Adjustment Mechanism (CBAM) proposal as a derivative of the EU-ETS, and the current status of studies on the introduction of carbon pricing in Japan. (For a recording of the video, presentation materials and summary of the webinar, click here).

I would like to share my takeaways with you from the webinar where I made opening remarks and listened to the discussions between EU and Japanese experts.

First, the EU-ETS system has been effective in reducing CO2 emissions since its inception in 2005, and it is now fully established, so there is no justification for rejecting the system itself.

Since 2005, the EU-ETS has been operated in phases 1, 2, 3, and 4, covering about 40% of the region's CO2 emissions in the power sector, manufacturing sector, and commercial aviation sector in the EU, based on the Cap & Trade principle.

According to Andrei Marcu (Executive Director, European Roundtable on Climate Change and Sustainable Transition, ERCST), between 2013 and 2020, the power sector which is covered by the EU-ETS has achieved an emission reduction of about 40% and the industrial sector which is covered by EU-ETS has achieved a reduction of about 20%. The price of EUA (EU allowances) (which are traded on the carbon market and therefore priced by the market) had been around 20-30 Euros/CO2 ton until 2020. However, since 2021, the price has risen, perhaps reflecting the EU's ambitious commitment to reduce emissions by 55% by 2030, and as of January 2022, the price is at a historic high of over 85 euros/CO2 ton.

Mr. Daniele Agostini (Head of Energy and Climate Policies, Enel Holding, Italy) said that carbon pricing is the most effective way to pursue decarbonization, and pointed out that in general, the Cap & Trade scheme is more efficient for decarbonization purposes than the carbon tax scheme in other developed countries. He said the adverse effects of price volatility can be countered by hedging. Mr. Axel Eggert (Director General, the European Steel Association, EUROFER) said that the European steel industry is committed to a 55% reduction by 2030 and carbon neutrality by 2050, but the challenge is to find policies that will make this possible. Although he is requesting that EU-ETS and CBAM abide by certain conditions, he is not in a position to reject those systems.

Second, the EU-ETS system is currently under discussion for further expansion, and CBAM is proposed to supplement the ETS system, and is currently evolving as a system that balances the economy and environment toward net zero.

In the European Commission's July 2021 proposal for the Fit for 55 package, it was proposed that the EU-ETS include the maritime sector, the road transport and buildings sector (as a separate setting from the existing ETS), and that the overall target for the sectors covered by the ETS should be a 61% emission reduction by 2030. It is also proposed that CBAM be initiated as a carbon leakage response to complement the ETS system from 2026, covering five sectors: steel, aluminum, cement, electricity, and fertilizer.

Mr. Marcu explained that the European Parliament's Environment Committee has proposed amendments to the Commission's proposals and is currently discussing them. Namely, the amendments include the addition of the three sectors of hydrogen, organic chemistry, and polymers to CBAM, and the accelerated introduction schedule. Mr. Eggert pointed out that the reduction of free allocation in the target sectors including steel is proposed together with the CBAM proposal. While supporting the CBAM proposal, the industry expressed its position that any reduction of free allocation should be done with caution, as it would put a damper on the industry's investment in low-carbon technologies.

In this way, the EU's policymaking process has been characterized by open and dynamic discussions in the process of European Parliament and European Council, taking into account the opinions of external stakeholders, since the Commission's proposal was delivered. Nevertheless, the Commission's proposals are usually finalized through such processes, and the basic direction of the proposal for expansion of EU-ETS system and CBAM is expected to be maintained.

Third, there has been a longstanding debate on the pros and cons of carbon pricing in Japan, and the momentum of the debate has been building recently, with Prime Minister Kishida, who took over from former Prime Minister Suga, announcing that he would find a direction for carbon pricing at the Diet session in January 2022.

Mr. Toshiyuki Sakamoto (Board Member, Director in Charge of Climate Change & Energy Efficiency Unit, The Institute of Energy Economics, Japan) introduced the ongoing discussions on carbon pricing in the study groups of METI and MOE, in particular the "GX League" proposed by METI to encourage industries to voluntarily commit to high ambition emission reductions and to create a voluntary credit market. In addition, he suggested that the introduction of a carbon tax has not been ruled out. Dr. Toshihide Arimura (Faculty Fellow, RIETI / Professor, Faculty of Political Science and Economics, Waseda University / Director, Research Institute for Environmental Studies, Waseda University) explained that carbon pricing theoretically internalizes external diseconomies and makes market mechanisms more efficient, and that in order to achieve net-zero emissions in 2050, emissions trading is necessary to reduce emissions and to offset the portion of emissions that cannot be reduced to zero through carbon absorption and removal. In fact, he introduced the fact that Tokyo, where the emissions trading system was introduced, reduced its emissions by 6.8% between 2009 and 2013. Thus, the debate on carbon pricing, including emissions trading and carbon taxes, is expected to accelerate in the future.

Fourth, Japanese stakeholders showed a high level of interest in the carbon price level. This suggests that Japanese industry is in the preparatory stage for the introduction of some kind of carbon pricing system.

Kazunori Takahashi (Deputy General Manager, Sustainability Promotion Division, Hitachi, Ltd.) reported that Hitachi has made a commitment to achieving carbon neutrality in its Scope 1 and 2 emissions by 2030 and carbon neutrality in Scope 3 by 2050. In order to achieve this goal, Hitachi introduced an internal carbon price in 2019 and raised the price from the initial 5,000 yen/t to 14,000 yen/t in 2021. In other words, the decision was made that in order to achieve carbon neutrality, the necessary investment would not be secured unless a carbon price of 14,000 yen/t was assumed. He explained that this price was set based on t international situation, including assessments of the situation made by IEA, and an internal survey of investment prospects (related to energy conservation and renewable energy). Hitachi's thinking and approach can be used as a reference for all Japanese industry.

Mr. Sakamoto explained that the climate change mitigation tax, which is Japan's carbon tax, is currently 289 yen/t, but if oil, coal and other taxes (including gasoline tax, which is used as a road funding source) are included, the tax rate is 4057 yen/t. If the FIT levy is included, the tax rate is 6301 yen/t. Professor Arimura explained that the Ministry of the Environment once presented a carbon price of 10,000 yen/t as an economic model calculation, and that recently there is a view that we should start with a low carbon tax rate and gradually raise it.

In any case, carbon pricing and its price level is a matter of great concern to industry as it directly affects their business, and whether the final burden will be accepted by users and consumers.

Finally, in response to Mr. Tetsuya Watanabe's (Vice President, RIETI) question, "What can Japan learn from Europe's long experience in carbon pricing?", Mr. Marcu, who has been involved in EU-ETS for a long time, provided an insightful answer. Mr. Marcu answered that he has been supporting the ETS, but that (1) the ETS alone cannot solve all the problems of decarbonization (i.e., policy mix of regulation, taxation, financial support, etc. is necessary), and it is difficult because it involves political decisions (whether 100 Euro/t is acceptable from the beginning, etc.), but the international situation has changed since the Paris Agreement, (2) the design (of the system) is difficult, i.e., it is important to create a real market, as there were times when the demand (for carbon) was flexible while the supply was inflexible, resulting in speculative price hikes, and (3) there is a need for a social aspect, a just transition, and a realistic approach. Mr. Marcu pointed out that the EU, as a pioneer, has learned a lot through hard work, but Japan, which has been monitoring the EU's efforts, should do better because the environment at home and abroad is changing. Mr. Marcu expressed his strong expectation that Japan would do better.

This webinar provided a very useful interactive discussion between leading speakers and panelists from the EU and Japan on the controversial topic of carbon pricing for net zero, focusing on Japan. It is hoped that the EU experience and lessons learned there can be applied to policy discussions in Japan, which is exactly what the EU-Japan Green Alliance is all about. The EU-Japan Centre for Industrial Cooperation will continue to work with specialist organisations such as RIETI and the IEEJ to provide meaningful information and contribute to policy discussions.

(This article reflects the author's personal opinion alone based on the author's understanding of the discussions during the above-mentioned webinar, and does not represent the official views of the Japanese or EU authorities, or that of the Centre.)

February 15, 2022

March 24, 2022