History of Regulations and Japanese Companies' Efforts to Reduce Greenhouse Gas Emissions [Part 1]

Global efforts to mitigate climate change have gradually progressed as scientific evidence of its impacts becomes clearer. However, concrete measures to reduce emissions are still in their infancy, and the size of the market needs to be further expanded in the future. The question is how to create a system in which activities to reduce greenhouse gas emissions bring economic benefits and disadvantages to those who do not engage in such activities, rather than measures that are undertaken with the best intentions of companies and people. Both developed and developing countries have been trying to find a way to do this while taking into account the impact on their own countries.

In this issue, we will introduce various rules and problems in greenhouse gas emission reduction, as well as issues that the Japanese government and companies will face in the future regarding greenhouse gas emission reduction.

Global Ruling on Greenhouse Gas Reduction

First, let's review the major milestones in global regulations for greenhouse gas reduction¹.

1) 1992:Adoption of the United Nations Framework Convention on Climate Change (UNFCCC) Adopted by the UN General Assembly in 1992, the Convention aims to address climate change. Countries agreed to set targets for reducing greenhouse gas emissions.

2) 1997:Kyoto Protocol This protocol set greenhouse gas (GHG) reduction targets for industrialized countries (OECD countries, countries in transition to a market economy, etc.). The targets were set only for industrialized countries because: 1) per capita emissions in developing countries remain low compared to industrialized countries; 2) the largest portion of global GHG emissions in the past and present have come from industrialized countries; and 3) the status and capacity of each country to address global warming are critical. 3) There are differences in the situation and capacity of countries to deal with global warming. Each country has set a legally binding numerical target of at least a 5% reduction from 1990 emissions levels. These were the first international frameworks to set emission reduction targets for each participating country. However, the United States refused to sign and withdrew from the agreement, and Russia was reluctant to sign, so the agreement finally entered into force in 2005.

3) 2015:The Paris Agreement The Paris Agreement is the second phase of an international, comprehensive framework for mitigating climate change, and plays an important role in setting targets for reducing greenhouse gas emissions after 2021. While only developed countries are subject to the obligations set forth in the Kyoto Protocol, under the Paris Agreement, participating countries around the world are obligated to reduce their emissions. The main goal is to keep global warming below 2°C and limit temperature increases to 1.5°C wherever possible. Participating countries were required to submit national voluntary targets based on the projects and capabilities of each country, and were subsequently obliged to report on their progress.

4) 2021:COP26 The Conference of the Parties to the United Nations Framework Convention on Climate Change (COP26), held in Glasgow, aimed to achieve the goals of the Paris Agreement and strengthen the international framework for addressing climate change. Countries submitted more ambitious decarbonization targets than the Paris Agreement and developed action plans for implementation. They also agreed to increase technical and financial assistance to developing countries.

Thus, over the past 30 years, the importance of reducing greenhouse gas emissions has been recognized and specific reduction targets have been set.

Kyoto Mechanism

In the 1990s, to help developed countries meet their emission reduction targets under the Kyoto Protocol, three mechanisms were approved for economically reducing greenhouse gas emissions through international cooperation. These mechanisms, known as the Kyoto Mechanisms, were the first economic mechanisms in which countries that had signed the Kyoto Protocol could participate if they met certain conditions, such as calculating their greenhouse gas emissions using a specified method and submitting the results annually to the Compliance Committee in a prescribed manner. There are three types of mechanisms: (1) JI (Joint Implementation), (2) CDM (Clean Development Mechanism), and (3) ET (Emissions Trading). All of these mechanisms are intended to allow developed countries to transfer funds and technology to developing countries and to expand greenhouse gas reduction projects on a global scale.

1. Joint Implementation (JI) Under this system, industrialized countries can implement GHG reduction projects jointly with other industrialized countries, and each industrialized country can use a portion of the GHG reductions achieved as its own reduction amount.

2. CDM (Clean Development Mechanism) CDM (Clean Development Mechanism)** (2) CDM (Clean Development Mechanism)** Under the CDM, developed countries provide technology and funds to implement greenhouse gas reduction projects in developing countries, and the credits (called Certified Emission Reductions (CERs) in the case of CDM) resulting from the emission reductions are shared between the country investing in the project (developed country) and the country in which the project is implemented (developing country). The project is divided between the project's host country and the project's recipient country. Projects must be undertaken with the objective of assisting the sustainable development of the developing country that will be the host country of the project.

3. ET (Emissions Trading) A system under which a portion of emission quotas can be traded among countries with reduction targets under the Kyoto Protocol. As a developed country, Japan has been able to cap its GHG emission quotas, and without reduction activities, it would not be able to keep its emissions within its quotas.

CDM Project Initiatives and Issues

Among Japanese companies, general trading companies (sogo shosha) took the lead in initiating CDM projects and some emissions trading initiatives (JI, which facilitates the exchange of emission credits among developed countries, was virtually unrecognized and did not function). The various tasks involved in CDM, from project identification to financing, obtaining environmental permits and licenses, arranging for construction companies, and managing the projects, are a specialty for a general trading company that has handled various large-scale infrastructure projects in countries around the world. The fields handled included biomass and biogas power plants, wind power plants, hydroelectric power plants, geothermal power plants, fuel conversion, waste methane gas recovery, and many others.

However, the CDM project faced a different problem from that of ordinary projects: the approval of credits by the United Nations. One of them was the approval of credits by the United Nations. The approval process is influenced by the members of the CDM Executive Board (governing body), the criteria for approval vary, the approval process is inconsistent, and the speed of processing takes longer each year, which affects the profitability of the project. The list is too long to mention, and this has been a source of concern for the companies involved. In the CDM, China (50%), India (14%), and Brazil (9%) accounted for about 75% of the countries from which emission credits were sold, while the United Kingdom (27%), Japan (20%), the Netherlands (14%), Italy (10%), and Canada (7%) accounted for about 75% of the purchasing countries. In this limited number of selling countries and multiple buying countries, the selling countries were looking to the buying countries to catch up.

China was quick to set up its own domestic system for CDM projects, and decided not to allow foreign investment of more than 51% in projects. In practice, this meant that no more than about 15% was allowed, making it virtually impossible to co-finance projects, which meant that developed countries had to bear the cost of developing the projects and then pay for the purchase of emission credits. In addition, China has taken measures to keep the price of emission credits above a certain level, and the profitability of the participating trading companies has continued to deteriorate.

In India, project implementation rights were also frequently implemented through an international competitive bidding system, which increased costs for participating companies and countries. CDM was not a profitable project for each trading company because of the extremely high risk for the developer.

In 2012, the CDM project, which had operated as a Kyoto mechanism, finally collapsed due to the EU's policy ban on the use of CERs and Japan's decision to withdraw from the Kyoto Protocol's numerical targets. The main reasons for this were the loss of competitiveness of companies in both regions due to the non-participation of the US, the EU's policy of maintaining prices in its own emissions market, and Japan's nuclear power plant shutdowns due to the 2011 Great East Japan Earthquake and Tsunami. In 2013, the CDM Executive Board established a voluntary amortization system and began the process of liquidating the 1.2 billion tons of CER inventory (CO2). Trading companies that had invested in the CDM business, as well as Japanese banks and some trading companies that were involved in ET futures trading, recorded losses.

The issue of double-counting of credits was concluded at COP26 in Glasgow in 2021, which was a step forward. The issue of double-counting of credits was concluded at COP26 in Glasgow in 2021, and is being addressed step by step.

Where Japan is now and where it is going

Currently, emissions trading markets based on the cap-and-trade principle have been established in Canada, China, South Korea, and some U.S. states, following the EU's lead with its EU-ETS. Meanwhile, Japan has introduced the J-Credit system, where only emission reductions are traded as credits[^3]. In Japan, however, the J-credit system, in which only emission reductions are traded as credits, has not yet been established. In order for each country to achieve the reduction targets agreed to in the Paris Agreement, the establishment of internationally shared rules is considered inevitable. However, to avoid repeating the failure of the CDM, in which the United Nations was the main body and some member countries were responsible for approving credits, we hope that the Japanese government and companies will make their presence felt through rule-making and participate as an operating entity in a sustainable mechanism.

On the other hand, companies must not only deal with business concerns directly related to emission credits, but also with strict conditions from an ESG perspective, such as not being able to finance, participate in competitive bidding, or initiate transactions unless their economic activities meet certain standards. These are the eyes of investors, public and private banks, corporations, and citizens, who monitor and evaluate corporate activities and take action accordingly.

For example, trading companies are selling their coal mines, selling coal-fired power plants and fuel conversion, operating power plants using renewable energy, and developing new energy businesses such as hydrogenation and ammoniation for large-scale transportation of such energy. The second part of this report will introduce these new energy businesses.

References

• 京都議定書目標達成計画
• 過熱する排出権争奪戦−−温暖化ガス削減ビジネスの実態
• 京都メカニズム
• 京都議定書CDM事業の破綻とその波及-「炭素恐慌」が残したもの
• 京都メカニズムの仕組み

脚注

1. Carbon dioxide (CO2), methane (CH4), dinitrogen monoxide (N2O), hydrofluorocarbons (HFCs), perfluorocarbons (PFCs), sulfur hexafluoride (SF6) ↩