Tatsuya Terazawa Chairman and CEO The Institute of Energy Economics, Japan
Message for April 2026
<Main Points>
1. Japan’s ETS starts in April: Mandatory coverage of 60% of GHG emissions
The national ETS (Emissions Trading System) will formally start in April 2026 after three years of preparation under a voluntary ETS system. It is called GX ETS in Japan, where GX stands for Green Transformation. GX ETS will be mandatory for companies emitting more than 100,000 tonnes of CO2 annually as the recent three-year average. The mandatory scope will encompass 300 to 400 companies, covering 60% of GHG emissions in Japan. Carbon pricing was first introduced in Japan in 2012 through the Global Warming Tax, which was levied on fossil fuels. To promote energy transition toward carbon neutrality by 2050, stronger carbon pricing has been put into place. The GX ETS will comprise one of the two pillars of the new carbon pricing in Japan. The other pillar will be the introduction of fuel surcharge, which will target all fossil fuels starting in FY 2028. The two pillars are expected to complement each other to promote energy transition and CO2 emissions reduction in Japan.
2. “Growth Oriented” design of ETS: Possible model for other countries
While the ETS started in EU back in 2005, Japan has been cautious in introducing ETS for nearly two decades. Concern about the impact on the industries was the major reason for the cautiousness. So how could Japan introduce ETS despite the expected strong opposition from the powerful industries? To overcome the expected resistance, GX ETS was labeled as “Growth Oriented”. It was stressed that the GX ETS will be designed to achieve both economic growth and CO2 reduction. In this Message, I would like to share with the readers the “Growth Oriented” design of the GX ETS. The success of Japan in introducing ETS despite the expected resistance from the industries could be a model for other countries, especially emerging economies, now exploring the introduction of ETS, by helping them overcome concerns about the impact on economic growth and opposition from industry.
3. Emission allowance is allocated to incorporate realistic potential of CO2 reduction
Some countries are allocating emission allowances to reduce their CO2 emissions in line with their path to realize their national CO2 emission reduction goals. While this may be considered a top-down approach, Japan has pursued a bottom-up approach, allocating emission allowances based on industry-by-industry analyses of the potential for CO2 emissions reduction. The main approach is allocating emission allowances based on industry benchmarks. The starting benchmark is set at the top 50% level of CO2-emitting efficiency of industrial activities, with continuous reduction to reach the top 32.5% level in five years. The pace of improvement is based on achievements that have been made under past energy efficiency measures. Benchmarks have been established for 20 industries that cover 90% of CO2 emissions from companies subject to the GX ETS, based on detailed analyses. For industries or companies with difficulties in applying benchmarks, “grandfathering” is used as the basis for allocating emission allowances. An annual reduction of 1.7% for energy related emissions and 0.3% for non-energy related emissions is required by the allocation of emission allowances based on grandfathering. The scale of the reduction is based on the expected reduction from switching to gas in ten years. As you can see, the emission allowances are set based on the potential for improvement, reflecting realistic expectation for emissions reduction based on detailed analyses. Such a realistic approach certainly must have helped enhance the acceptance of the GX ETS by industries.
4. Free emission allowance is allocated until FY 2033
Emission allowances will be allocated without charge until FY 2033. After FY 2033, auctions will be conducted in phases to allocate emission allowances for the power industry. After that, power companies must pay for emission allowances. The current GX Promotion Law, which sets out the rules of GX ETS, stipulates that only the power industry will be subject to auctioning. In the future, as GX ETS becomes more established, this decision may be revised to apply auctions to other industries. The grace period for the auctioning and its possible narrow scope may help gain acceptance from industries. On the other hand, the fuel surcharge will be imposed as early as in FY 2028. The reasons for the earlier introduction are that industries are accustomed to levies and taxes and no serious challenges are expected for their introduction, which is quite different from the GX ETS, which is new and faces more challenges. In addition, the scale of the fuel surcharge is designed to be kept within the reduction in the revenue from the existing taxes on oil, gas, and coal. As this tax revenue is expected to start declining, room for the fuel surcharge is expected to be developed in a few years.
5. Support for energy transition precedes introduction of ETS
The revenue from the GX ETS and fuel surcharge will be used to support energy transition efforts including R&D and CfD (Contract for Difference) for hydrogen and CCS, and investment support in low-carbon technologies. While the industries must bear the burden of carbon pricing including GX ETS, the prospect of the revenue being used to support the industries’ energy transition helped secure their acceptance. In addition, support for GX has been in place for three years ahead of the formal start of the GX ETS. While the revenue from the fuel surcharge will not come before FY 2028 and the revenue from the auctioning under GX ETS will not come before FY 2033, GX transition bonds have been issued to finance the support for GX since FY 2023. The GX transition bonds will be paid back from the revenue generated by GX ETS and the fuel surcharge in the future. Support for GX coming before the introduction of carbon pricing measures is another factor behind the acceptance by industry. This demonstrates that sequencing is important for policies and politics.
6. Long-term balance of the budget is maintained
Many countries may be facing the dilemma between the need to promote energy transition and the need to balance their budgets. Japan has overcome this dilemma by supporting the energy transition now and by financing the expenditure with the revenue from carbon pricing later. The maintenance of the long-term balance of the budget through this structure could be a model for countries struggling with such a dilemma.
7. Price band is introduced to encourage investment in energy transition
A market will be established to trade emission allowances starting in FY 2027. If the price determined by the market goes up and down wildly, it may not be able to serve as a good guide for investment activities requiring long time horizons. To encourage investment in energy transition activities, the Government of Japan decided to introduce a price band for emission allowances. The initial floor is set at 1,700 yen/tCO2 which reflects the market price of domestic energy efficiency credits. The initial ceiling is set at 4,300 yen/tCO2, which reflects the cost of fuel switch from coal to gas. The level of the price band will be raised every year based on a formula including the cost of capital (3%) and inflation. The level of the price band was set to be reasonably high enough to encourage investment in energy transition while being low enough not to be too burdensome for energy-consuming industries. Depending on their viewpoints, companies may have different opinions about the price level. But it appears that the price band was set at a balanced level judging from the limited noise from industry.
8. Carbon credits are allowed to offset up to 10% of emissions
To facilitate companies’ efforts to keep their emissions within the allocated allowances, the Government has allowed the use of carbon credits to offset any overshoot of actual emissions. Carbon credits can be used up to 10% of the companies’ emissions. Two types of carbon credits are allowed initially. One is the government-endorsed domestically developed carbon credits called J-Credits. The other is another government-endorsed carbon credits developed outside of Japan under the bilateral frameworks established between Japan and the host countries, i.e., Article 6.2 of the Paris Agreement. This credit is called JCM (Joint Crediting Mechanism). Japan may be leading the world in the wide use of carbon credits. The 10% upper limit is higher than many other countries. The acceptance of international carbon credits is still a minority globally. Japan has the potential to use some negative-emission credits by expanding the scope of J-Credit and JCM. The generous acceptance of carbon credits can help industries meet their emission targets.
9. Opportunities for international providers of low-carbon solutions
As explained, Japan’s ETS could serve as a model for countries considering the introduction of carbon pricing but concerned about the impact on growth and opposition from industry. In addition, Japan’s ETS could offer opportunities for various international players interested in the Japanese market. For companies considering providing low-carbon solutions including hydrogen, ammonia, and CCS, the GX ETS can help narrow the cost gap with conventional energies by adding cost to them. For countries and companies considering developing carbon credits and exporting them in partnership with Japan, Japan’s ETS could provide a rare opportunity by accepting international carbon credits. For companies developing technology-based negative-emission credits, Japan could be one of the first markets to deploy them in the near future. Japan’s ETS deserves attention from various international players providing low-carbon solutions and countries considering the introduction of an ETS. I intend to update the readers in my Messages with the developments in the GX ETS, including the detailed design of the transaction market, which is expected to start in FY 2027. ■The 11th IEEJ/APERC International Energy Symposium- Advancing Realistic Energy Policies for Addressing the Energy Trilemma - I would like to inform you of the 11th IEEJ (The Institute of Energy Economics, Japan) /APERC (Asia Pacific Energy Research Centre) International Energy Symposium which will be held on 24 April 2026 as a hybrid meeting. The theme of this symposium is " Advancing Realistic Energy Policies for Addressing the Energy Trilemma". Under this theme the symposium will explore the issue through the following three sessions:
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