J@pan Inc -- Japan: Land of the Rising Target?

By Willhemina Wahlin

Japan, steeped in a tradition of honor and commitment, must face an embarrassing truth: it has not made a dent in its Kyoto Protocol target emissions, its 6% target reduction soaring to an 8.3% increase by 2003, which essentially put the target in the vicinity of 15%. So the protocol's redfaced host country is bumping up its involvement in the treaty's three mechanisms: Joint Implementation, the Clean Development Mechanism and Carbon Emissions Trading. Although still in their infant stage, these mechanisms are already big business. Japanese corporations are among the world's largest investors in carbon credits. Strangely, however, there are no plans to require mandatory emission reductions or to create a trading scheme within Japan. While certain government ministries are still debating the best course of action, Japanese corporations have been there, bought that. Environmental groups contend that if Japan is to reach its target it must adopt more stringent domestic measures, and quickly, to coincide with the investment boom in carbon credits offshore.

Mechanisms of the Kyoto Protocol
The protocol requires all Annex I (developed nation) signatories to jointly reduce greenhouse gas emissions by 5.2% of the baseline 1990 levels by 2012. Each nation is given individual targets to achieve this, Japan's being 6%. Non-Annex I countries (developing countries such as China, India and Brazil) are not bound to set target reductions, but are encouraged to reduce emissions.

For Japan, one of the biggest challenges to reducing domestic emissions is its abatement cost. "According to one estimate, "explains Mr. Hisane Misake, a commentator on international economics, "it costs Japan about $110 to eliminate a ton of carbon, compared with about $80 for Europe and $50 for the US, on average." Despite this, there is still much that can be done domestically, but the government is reluctant to take measures that might reduce its corporations' competitiveness. This has become a sticking point between the Ministry of Environment (MOE), which favours an environmental tax on fossil fuels, and the Ministry of Economy, Trade and Industry (METI), a proponent of private sector investment in overseas projects in preference to mandatory target reductions for industry.

The three protocol mechanisms come under the auspices of the United Nations Framework on Climate Change (UNFCC). This regulatory body approves applications for Joint Implementation and Clean Development Mechanism projects, and monitors their progress to ensure they are delivering measurable greenhouse gas reductions before carbon emission reductions credits are earned.

Joint Implementation
Joint Implementation is the exchange by two Annex I nations of ideas or technology for reducing emissions. This could be technology for solar panels, wind farms, or still evolving technologies for renewable energy or improvements in energy efficiency.

The Clean Development Mechanism (CDM)
This mechanism has the potential to accelerate investment in developing countries sustainably, by encouraging Annex I countries to invest funds in or provide technology transfers for projects that reduce greenhouse gas emissions in Non-Annex I countries.

This earns Annex I countries or their corporations carbon credits, which can be put toward their target reductions. Japan's many CDM projects include the destruction of
hydrochlorofluorocarbons (HFCs) and other greenhouse chemicals, methane gas capture from Brazilian landfills and Chinese coal mines, and biomass (such as electric power generation from rice husks in Thailand).

CDM has two stipulations. Firstly, a project must be additional, that is, without the existence of CDM it would not have happened. For example, the Gangwon Wind Park Project in the Republic of Korea received the financial backing of two Japanese corporations, Marubeni and Eurus Energy Japan. The project qualified as 'additional' because budgetary constraints would otherwise have induced the Korean Government to build fossil fuel plants rather than invest in renewable energies. CDM provided an avenue for both parties to benefit from the technology transfer: the wind farm reduces Korea's carbon emissions and fossil fuel dependency, and the investors earn carbon credits. Marubeni, in particular, is increasingly interested in trading credits; so CDM is a valuable investment.

This project also addressed CDM's second stipulation: that a project have sustainable development value for the host nation. Wind, a renewable energy source, is a favourite of environmental groups.

CDM projects can be controversial, because not all that have been approved can be regarded as additional or sustainable. One such type of project is the destruction of powerful greenhouse gases, such as HFCs. The trick is that a carbon credit is worth 1 tonne of CO2 emission reductions, and while CO2 is certainly the most prevalent and problematic of all the greenhouse gases, it is not the most powerful. For instance, if a company destroys a tonne of HFC, which has 11,700 times the global warming potential of CO2, it can earn up to 11,700 carbon credits, instead of just the one for carbon dioxide. However, HFC destruction projects, while not unbeneficial, hold little sustainable development value for the host country. "It's an already proven technology," says Naoyuki Yamagishi, the World Wildlife Fund Japan's Climate Change Policy Officer. "It's easier to do in developing countries. You actually just purchase the equipment and the plant, and that's it."

METI shares this opinion of these types of high-yielding projects. However, its Director of Environmental Affairs, Dr. Hiroshi Yamagata, says while the government encourages investment in sustainable projects rather than 'over the counter' market trading, such projects must be cost effective, ensuring the maximum amount of credits for the taxpayer's yen. To date, the government has invested most heavily in HFC destruction, landfill-gas capturing and other high-yield projects; its investment in renewables or energy efficiency has been minimal.

Trading companies invest in CDM to earn potentially lucrative carbon credits. They have plunged head first into the high-yield projects, particularly HFC destruction. Renewable and energy efficiency projects require a greater commitment by developers and have a relatively longer payback horizon in terms of earning credits.

Some investors have called for a review of the approval process for CDM projects. They blame the lengthy, complicated process for steering companies away from renewable energy projects to projects with the fastest returns. This is cause for concern environmentalists, who would like to see the full potential of CDM realized.

Carbon Emissions Trading
Carbon trading allows a country to 'buy the right' to emit greenhouse gases. This is more than just allowing wealthy countries to buy the right to pollute. Firstly, there are two systems under which a country can sell a credit: if they are under their emission allowance, they can sell their credits or they can earn credits through hosting project-based schemes, such as joint implementation and CDM. Credits can be exchanged for cash, equity or participation in projects that provide 'in-kind'contributions.

There are a growing number of Carbon Funds specializing in carbon trading, both for governments and the private sector. Popular are pooled funds. Investors pool their funds and a specialist administrative body buys credits on their behalf. Japan Carbon Finance is a good example of a pooled fund. Its overseeing bodies, the Development Bank of Japan (DBJ) and the Japan Bank for International Cooperation (JBIC), manage approximately US$145 million for some of Japan's largest corporations to purchase credits on behalf of the Japan Greenhouse Gas Reduction Fund (JGRF).

Japanese trading companies have invested in funds all over the world. While some of these companies, which have other divisions in heavy industry, such as Mitsubishi, could use their market-acquired credits for their own voluntary emission reductions, they could, hypothetically, also sell them for a profit to the Japanese government in the future, and if the prices of credits rise as expected, the return could be hefty. The current market price for credits is around US$8-15, and if future predictions are correct, that price could rise to US$25 in just a few years.

Japan has officially announced it will use credits for 1.6% of its target reductions, but this figure is only for the government. While the private sector is not legally bound to reduce its emissions, pressure from Keidanren has seen major polluters accept high voluntary targets in order to avoid mandatory ones. This means they have plenty of interest in accruing credits of their own, but, as explained below, it does not provide the opportunity of a domestic trading scheme within Japan. This means that, aside from the possible credits Japanese investment firms could later sell to the government, the estimated 100 million carbon credits that the Japanese government will need within the next five years must be purchased from international sources.

For Japan, the danger is that once the deadline for targets draws closer, many companies from the EU could start scouring the international market for credits, outside of their domestic trading scheme, which could drive up the price. For Japanese trading companies, this could be a windfall, but it could prove disastrous for the government, the sole Japanese body legally bound to a target.

Within the Kyoto Protocol, each Annex I country must include domestic measures as part of its overall plan to reduce emissions. The Japanese government introduced the Climate Change Program in 2002, upon ratification of the protocol, which included the introduction of over 200 policies and measures to mitigate climate change. This was followed by the Kyoto Achievement Plan of April 2005, which the Japanese government just recently amended again in March/April 2006. The plan has allocated a US$100 million budget for 2006 and authorized the government agency NEDO (New Energy and Industrial Technology Development Organization) to use that money to acquire carbon credits on behalf of the government.

However, what's also notable is that the plan does not call for reduction of emissions stemming from energy use. This is strange. Japan's complete blow-out of its target is partly attributable to the energy sector, most notably the Tepco nuclear accident of 1999, which caused the temporary shutdown of 17 nuclear reactors, boosting the need for thermal power. Such interruptions to Japan's nuclear power supply raised emissions by 4.9%, yet METI remains reluctant to set mandatory targets for industry, or consider the benefits of a domestic trading scheme. Dr. Yamagata explains that there will be no such scheme in Japan "because Japanese industries have a voluntary fund...[the] Association of Power Companies [has] committed to a 20% reduction of kilowatt power until 2010, this is very high pressure on the companies."

He added that it may be difficult for other nations to comprehend the cultural reasons for such a decision. "In the Edo era, the samurai, once they commit to something and fail, he has to cut," Dr. Yamagata said, making a slashing gesture across his stomach. Asked, then, if reductions in the energy sector depend on the samurai spirit, he laughed, "I hope so."

But Mr. Yamagishi explains that the WWF would very much like to see a domestic trading scheme within Japan. "Introducing domestic emissions trading means that each company has to curtail its own emissions, [as they] have the same amount of emission allowances. In that way, each company has a more direct incentive to reduce emissions."

A possible cause for METI's reluctance to set mandatory targets for industry is that its principal objective is to support Japanese industry in maintaining, and improving, its international competitiveness. So for METI, the push for investment into Joint Implementation and CDM projects makes a lot of sense, as projects in developing countries would be much cheaper investments, in turn lowering the cost of abatement. Now that the budget is passed and NEDO given full authority to act on the government's behalf, Dr. Yamagata is keen for the government to start investing in many more projects right away.

The Japan Greenhouse Gas Reduction Fund
Most of the large utility corporations in Japan have invested heavily in the JGRF. Mr Takao Aiba, the Development Bank of Japan's (DBJ) Deputy Director of the Policy Planning Department of Environmentally Sustainable Development, first raised the idea of CDM investment back in 1999. "When we began to talk with Japanese companies in the year 2000, their response was not so great and only a limited number of power companies were interested in [the idea]." Many of the companies Mr. Aiba approached had planned on more independent purchasing schemes, mainly through the use of carbon funds. "But without government backing their procurement is not safe," he said, adding that JGRF has the backing of both MOE and METI.

JGRF's investors include Tokyo Electric, Nippon Oil, Sony, Sharp and JGC Corporation, spanning the utility, manufacturing and oil, engineering and trading sectors. Mr. Aiba, who has worked within the field of climate change policy for many years, is a strong believer in the potential of CDM, and while the JGRF has invested in many high-yielding projects, its main project area is in biomass. "CDM is quite important to stimulate activities in developing countries, especially China or India, with rapidly growing economies," Mr Aiba says. "In that sense CDM has very good potential to combat climate change in the long-term." He added that today many corporations approach JGRF with money to invest, and there is the possibility that they may someday assist the government in credit acquisition. Japan Carbon Fund, which buys credits and then sells them to JGRF, has announced the achievement of half of its credit acquisition target.

But the fastest movers in CDM project investment and credit acquisition have been the Japanese trading companies, such a Mitsui, Sumitomo and Mitsubishi (some of which are, cleverly enough, also investing in JGRF). In fact, a cornering of the high-yield project market has ensured that such projects have just about all dried up. "High-globalwarming potential projects are now largely all assigned," said Dr. Euan Low, Tokyo Representative of the global engineering consultants Mott MacDonald. "Japanese trading companies know the detail of every single factory in the world producing hydrochlorofluorocarbons, nitrous oxide etc. Emissions reductions purchase agreements have been secured to provide remedial technologies and to buy the credits at an agreed price." For a relatively low investment cost, these trading companies have managed to accrue large amounts of credits with little risk.

There's no doubt that Japan knows a good investment when it sees one. CDM in particular has the potential to radically improve development assistance to poorer countries. But as altruistic as its investment in CDM might seem, Japan still cannot avoid the fact that much remains to be done on the home front. This is clearly visible in everyday life here. Truck drivers nap with their diesels idling and supermarkets package groceries in polystyrene. These are small things, for sure, but they add up to indifference to climate change. Japan has a real chance to reach its target by 2012, but it must keep an eye on its own backyard. JI