Japan - The rising sun for carbon markets: part I

Japan has exemplary carbon credentials. It is amongst the most energy and carbon efficient economies in the world, and one of its most beautiful cities gave its name to the UN’s Kyoto Protocol. Despite extraordinarily difficult economic and political circumstances, Japan is quietly forging ahead with initiatives that speak volumes about its dismay and disaffection for the UN-led process to deliver a global deal after the flawed Kyoto Protocol ends in 2012. Is Japan leading the way with a model that will inspire other nations to set their own courses of action, or, is it plotting a cunning escape from the bleeding edge of the UN process?

Steadfast in the storm

In February this year, Japan slid from the world’s second largest economy to third when China’s 2010 GDP figure of $5.8 trillion eclipsed Japan’s ($5.5 trillion) for the first time. Japan’s new reality reflects a drop in exports and consumer demand, while China benefitted from a manufacturing boom as yet more of the world’s goods are made and exported from China’s carbon intensive economy. It’s still too early to predict how the March 2011 Tōhoku earthquake and tsunami might further affect Japan’s fortunes. But, despite an almost perfect storm of environmental, economic, and political woes, the country is holding steady on its climate change commitments and is deepening its involvement in carbon trading and offsets.

That isn’t because of loyalty to the United Nation’s Framework Convention on Climate Change (UNFCCC) which launched its Kyoto Protocol (KP) in Japan in 1997 to set and apply reduction plans amongst the 154 signatory countries. On the contrary, Japan’s stoic and steadfast commitment to reducing greenhouse gas emissions by 25 per cent against a 1990 baseline by the end of this decade comes as its faith in the UN process and protocols reaches a new low. Neither does this indicate a nation playing fast and loose with its GHG emissions, as this is an economy built at the leading edge of energy efficiency – Japan is currently 5x more carbon efficient than China and twice as efficient as the US.

So, despite phenomenally adverse conditions over and above global economic woes, Japan is in the process of strengthening two trading and offset initiatives to keep its GHG reduction plans on track. The first shifts Japan’s focus on carbon offsets from the CDM to bilateral agreements with selected SE Asian countries, and the second is a system to spur voluntary carbon offsetting within its domestic market.

These two initiatives are in stark contrast to developments in the EU which is taking a different track with respect to the future of the Kyoto Protocol after it lapses at the end of 2012; and, which has generally seen voluntary initiatives as a distraction rather than a complement to regulation.

Escape from Kyoto

The shift in interest from the Kyoto CDM mechanism to bilateral alternatives is born out of frustration with the cumbersome and unpredictable Clean Development Mechanism (CDM) process of the Kyoto Protocol, and fuelled by a desire to export low-cost, clean technology in return for carbon credits that could help Japan meet its reductions goal. The Japanese government is seeking to promote project types not yet recognised under the CDM, such as nuclear power plants and clean coal, as these will tee-up its industrial giants for export of low-carbon kit and expertise and increase its influence specifically in the South East Asian region. It will wait to see whether December’s U.N. negotiations in Durban deliver a legally binding deal or resort again to ineffectual voluntary pledges before cranking up this bilateral approach. However, it is doing the groundwork already with three SE Asian countries.

In sharp contrast to the EU

So, it’s good to know that the Japanese have a plan to ensure that capital for reductions programmes in those parts of the world where GHG emissions are growing fastest (specifically SE Asia) continues to flow. Especially now as the EU is making plans to curtail its use of CDM credits within the EU ETS from 2013 onwards from just those very countries. The EU is backing reforms to shift the focus of the CDM from the developing economies in the East and Latin America to least developed economies in Africa.

But there is an important paradox in the EU’s plans. Emissions in least developed regions like Africa are amongst the lowest in the world, and according to International Energy Agency forecasts, are unlikely to grow at anything like the rate we can expect in the SE Asia market (South Africa is a notable exception). That makes it very difficult to source large volumes of reductions for use within the EU ETS from economies which already have some of the lowest emissions per capita in the world – not because they are efficient (they are not), but because they are economically impoverished.

The EU’s proposed escape from this paradox is through a method for generating carbon credits by taking ‘suppressed demand’ into consideration in the baselines used to calculate carbon emission reductions in CDM projects.

This approach, now gaining favour within the reforms underway in the CDM, allows the baselines of least developed economies to be set at levels which assume economic development is not constrained by poverty and/or lack of infrastructure or suppressed industrial and consumer demand. Under the suppressed demand approach, countries can generate carbon finance to invest in low-carbon, clean energy without having to first ‘become dirty’. The consequence is that reductions under suppressed demand methodologies do not in fact reduce the existing GHG emissions inventory – they ensure such emissions do not arise in the first place.

And it has some merit depending on how you look at carbon finance. If you think carbon finance is about funding sound projects that reduce existing GHG emissions, then the Japanese approach is for you. If you think carbon finance is about solving world poverty and helping poorer nations leapfrog to clean, low carbon economies then the European proposals for suppressed demand within the CDM are a better fit.

Whichever approach you favour, the CDM reforms and suppressed demand methodologies and projects will take time to develop and implement, so it’s encouraging that the Japanese look set to pick up the slack. This is vitally important because a period of several years without either CDM or new mechanisms would mean market-based activities to cut carbon emissions will scaled down instead of up, losing vital time and momentum to drive real reductions out of the global economy.

Next blog: Part II: How Japan is encouraging domestic offsetting to help it meet it reduction targets

Jonathan Shopley is managing director of UK-based The CarbonNeutral Company. Read more CarbonNeutral blogs here.

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