Chairman’s Message

The Japanese Government submitted the bill earlier this year to introduce an ETS (Emissions Trading System) to its Diet. The ETS will mark a significant step in the introduction of carbon pricing in Japan. In this month’s Chairman’ s Message, I would like to explain the design of the Japanese ETS.

<Main Points>

Three steps to introduce carbon pricing in Japan.

ETS to be introduced in FY 2026 to cover up to 60% of CO2 emission in Japan.

Allocation of emission allowances must be further worked out.

Ceiling and floor of the carbon price will be introduced for predictability.

Cross-border carbon credits will be recognized.

Carbon removal methods will be recognized in the future as credits.

A carbon surcharge on imported or domestically produced fossil fuels starting in FY 2028 and auctioning for the power sector in FY 2033.

Carbon pricing will help promote hydrogen and CCS.

1. Three steps for carbon pricing in Japan

While Japan is not necessarily known as a country with carbon pricing, the fact is that Japan already has a carbon pricing mechanism. A carbon tax was introduced in 2012 after the Fukushima nuclear accident when the government pushed for non-nuclear alternatives such as renewables. The tax rate was eventually raised to 289 Japanese yen per ton of CO2 emissions. The tax rate was modest in retrospect, as it was kept low to broadly and lightly distribute the burden across the Japanese society, and it marked the first explicit carbon pricing in Japan.
　With the pledge to achieve carbon neutrality that was made by the Japanese Government in 2020, the Government had been studying the broader introduction of carbon pricing, so-called “Growth-oriented Carbon Pricing”. Former Prime Minister Kishida decided in 2022, as part of his GX Strategy, or Green Transformation Strategy, to introduce carbon pricing in a broader manner.
　Following the introduction of the carbon tax in 2012, the second step is the introduction of a mandatory ETS in FY 2026, preceded by a three-year voluntary ETS named GX ETS. The bill submitted to the Diet earlier this year will be the legal framework to introduce mandatory GX ETS.
　The third step is the introduction of carbon surcharge in FY 2028, which will be charged against fossil fuels reflecting their carbon content, and auctioning allowances for the power sector in FY 2033. Revenue from the carbon surcharge and auctioning will repay the GX bonds, which finance measures supporting GX, with the total budget amount expected to reach 20 trillion yen, or $133 billion, over the next ten years.

2. ETS will cover 50-60% of CO2 emission in Japan

The target of mandatory GX ETS will be companies emitting more than 100,000 tons of CO2 annually. It is expected that 300-400 companies will be covered amounting to 50-60% of total CO2 emission in Japan. While the current GX ETS in Japan is voluntary, it will be mandatory from FY 2026.
　Targeted companies will be allocated emission allowances each year. If the actual emissions exceed the allowance, the relevant company must purchase carbon allowances, equivalent to the gap, from others. Companies with actual emissions below the allocated allowance can sell the surplus allowances to other companies. The excess allowances can be carried over to the next year.
　The mandatory GX ETS will start on April 1st 2026 (FY 2026). The first accounting of emissions will be conducted in FY 2026. The allowance will then be allocated for two years, FY 2026 and 2027. The gap between the allowance and the actual emission will be calculated for both FY 2026 and FY 2027. After the first two years, the cycle of the process will be annualized.

3. Allocation of emission allowances must be further worked out

For large CO2 emitting industries, benchmarking will, in principle, be used as the basis for allocating emission allowances. The specified intensity in the respective industries will be used as the target to achieve. For other industries, where benchmarking is difficult, grandfathering will be used as the basis. The exact split of industries between the two approaches needs to be worked out.
　In addition, leakage risks, R&D investment, and changes in activities level will be reflected in the allocation. For grandfathering, efforts made before the introduction of the GX ETS will also be reflected. The detailed methodology of such reflection must be further worked out.
　During the initial stages, allowances will be allocated free. After FY 2033, auctions for the allowances for the power sector will be initiated. After then, the power sector will have to start paying for emission allowances.

4. Ceiling and floor of the carbon price will be introduced to enhance predictability

Carbon pricing is very important to guide investment towards clean energy technologies. To ensure steady investment, predictability of the carbon price level is considered important. Additionally, we need to avoid excessive burden on the industries.
　For these reasons, a ceiling and floor for the carbon pricing will be introduced. The Government will intervene to make sure that the carbon prices stay within this range. The exact methodology of setting the ceiling and the floor must be further worked out.

　5. Cross border carbon credits will be recognized

Based on the Paris Agreement Article 6-2, bilateral cross border carbon credits can be recognized towards achieving a country’s NDC. Japan has been promoting JCM (Joint Crediting Mechanism), which is a framework to develop carbon credits across borders. JCM is a bilateral framework, under which the Japanese Government has engaged in agreements with 29 countries. The Japanese Government is in the process of transforming these 29 JCM agreements to be recognized under the Paris Agreement Article 6-2.
　Cross-border carbon credits developed under JCM consistent with Paris Agreement Article 6-2 will be recognized as eligible credits that can be used in the GX ETS. Through this process, overseas carbon credits can be part of the GX ETS market in Japan and be monetized.
　I believe that these cross-border JCM credits could be a major pillar of the initiatives under AZEC (Asia Zero Emission Community). Members of AZEC, mostly ASEAN countries, can develop carbon credits in their countries and transfer them to Japan to be monetized in the GX ETS. This can generate revenue in ASEAN countries and also help Japanese companies meet their carbon emission reduction responsibilities. This can be a truly win-win for all.

6. Carbon removal will be recognized in the future as credits

Carbon removal will be increasingly important as we will eventually have to deal with the remaining CO2 emission. DACCS (Direct Air Capture with Carbon Storage), BECCS (Bioenergy with Carbon Capture and Storage), and other nature-based negative emission solutions such as the enhancement of forest carbon stocks will be essential for carbon removal. The IPCC is working on the methodology to account for carbon removals other than forest, which can contribute to the national GHG (Green House Gas) Inventories.
　Carbon removal will be recognized as credits by JCM and the Japanese domestic crediting scheme, which can then be used in the GX ETS. The monetization of carbon removal measures through the GX ETS will help promote their deployment. Especially when this is combined with JCM, carbon removal measures can be deployed internationally, including in ASEAN countries. The possibility of capitalizing on ASEAN countries’ endowments for carbon removal will be much greater than if only pursued within Japan with limited endowments. Once again, this can be a win-win for many.

7. A carbon surcharge on fossil fuels and auctioning for the power sector

The third step for carbon pricing will be the introduction of a carbon surcharge on domestically produced and imported fossil fuels in FY 2028 and auctioning for the power sector in FY 2033. The surcharge will be charged against fossil fuels based on their carbon content. The details on the auctioning of allowances will be worked out in the future before its introduction. The potential overlap between auctioning and carbon surcharge will be addressed then.

8. Carbon pricing will help promote hydrogen/ammonia and CCS

In my previous Messages, I have written that the Japanese Government has pledged 3 trillion yen or $20 billion to promote hydrogen/ammonia through CfDs (Contract for Differences) and through infrastructure development support.
　For CCS, a legal framework to govern CCS projects in Japan has been introduced. But the framework for support of CCS is still pending. While budget measures are very important in promoting hydrogen/ammonia and CCS, budget alone cannot lift off the market. The required scale of fiscal support is way too large.
　This is why we need to have complementary policies to promote hydrogen/ammonia and CCS. In this regard, carbon pricing can play a great role. By adding the cost of carbon to conventional energies, the cost gap between hydrogen/ammonia, CCS, and conventional energies can be narrowed. This will help promote hydrogen/ammonia and CCS while reducing the necessary budget required.

9. Three points to watch for international readers

The details of the GX ETS may not matter too much for many international readers. But I believe that there are three points that deserve attention among international readers.
　First, for ASEAN countries and others who have the potential of developing carbon credits, participating in JCM projects can help monetize the environmental value of those projects through GX ETS. The cross-border carbon credits can bring revenue to such countries and make the projects more bankable.
　Second, companies engaged in carbon removal activities including DACCS, BECCS, and nature-based solutions, can accelerate such activities by participating in the GX ETS through the Japanese domestic crediting scheme in Japan as well as through JCM with other countries.
　Third, players engaged in hydrogen/ammonia and CCS should pay close attention to follow the detailed design of the GX ETS to assess the potential future deployment of them.
　Recognizing such interests, I shall update you on the development of carbon pricing in Japan in my future Chairman’s Messages.