FACTSHEET
Experiences with Carbon Pricing inGermany, the EU and Japan

Authors:
William Acworth, Maia Hall, Andres Felipe Olarte Penaadelphi consult GmbH

Johanna Schilling, Rumi Hasegawa
ECOS Consult GmbH

Date: 16.02.2021

Prepared for the Federal Ministry for the Environment, Nature Conservation and Nuclear Safety (BMU) in
the context of the German-Japanese Environment and Energy Dialogue Forum („Wissenschaftliche
Ausrichtung der deutsch-japanischen Kooperation über ausgewählte Klimaschutztechnologien im
Rahmen der deutsch-japanischen Klimaschutzerklärung und des deutsch-japanischen Umwelt- undEnergiedialogforums“, FKZ UM18 18 40 40).

ECOS Consult v Westerbreite 7 v 49084 Osnabrück v Germany v Tel: +49 (0) 541 911 909 90 v Email: info@ecos.eu v www.ecos.eu

Factsheet „Experiences with Carbon Pricing in Germany, the EU and Japan”

Disclaimer
This report has been prepared by ECOS Consult GmbH and adelphi consult GmbH. The perspectives andconclusions expressed in this report are those of the employees of ECOS GmbH and adelphi consult GmbH.
All information and data are carefully researched. However, neither ECOS GmbH, adelphi consult GmbH,nor any of their employees, contractors or subcontractors make any warranty, expressed or implied, orassume any legal or other responsibility for the accuracy, completeness or usability of any information,
product or incorporated process, or assure their use private rights would not be hurt.

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Factsheet „Experiences with Carbon Pricing in Germany, the EU and Japan”

Contents
1

Introduction ................................................................................................................... 5

2

Carbon pricing design and diffusion ................................................................................ 7

3

4

2.1

Why price carbon? ............................................................................................................ 7

2.2

Types of carbon pricing .................................................................................................... 7

2.3

Global diffusion of carbon pricing .................................................................................... 9Experience with carbon pricing mechanisms in Germany and the EU ............................. 11
3.1

The EU ETS ...................................................................................................................... 11

3.2

The German Fuels ETS .................................................................................................... 14

Experiences with carbon pricing mechanisms in Japan .................................................. 16
4.1

4.1.1

JVETS ........................................................................................................................ 18

4.1.2

Joint Crediting Mechanism (JCM)............................................................................ 19

4.1.3

Tax for Global Warming Countermeasures............................................................. 20

4.1.4

Recent developments.............................................................................................. 21

4.2

5

6

National level: JVETS, JCM, and recent developments .................................................. 16

Subnational level: Tokyo and Saitama............................................................................ 22

4.2.1

Tokyo Metropolitan Government ........................................................................... 22

4.2.2

Saitama Prefecture .................................................................................................. 24

Current carbon pricing debates ..................................................................................... 24
5.1

Industrial decarbonization .............................................................................................. 24

5.2

Electricity sector decarbonization .................................................................................. 26

5.3

Cooperation and linking ................................................................................................. 30

Conclusions .................................................................................................................. 31

Appendix............................................................................................................................. 33
Appendix 1: The EU ETS at a glance .......................................................................................... 33
Appendix 2: The EU ETS at a glance .......................................................................................... 34
References .......................................................................................................................... 36

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Factsheet „Experiences with Carbon Pricing in Germany, the EU and Japan”

List of Abbreviations
CBAM

Carbon border adjustment
mechanism

CCS

Carbon capture and storage

CDM

Clean Development
Mechanism

JPY

Japanese yen

JVETSJapan Voluntary Emissions
Trading System

LPG

Liquefied petroleum gas

LRF

Linear reduction factor

METI

Ministry of Economy, Tradeand Industry

CO2

Carbon dioxide

CO2eCarbon dioxide equivalent

EEA

European Economic Area

MoEJ

EITE

Emissions-intensive andtrade-exposed

Ministry of Environment
Japan

MRV

Monitoring, reporting andverification

ETS

Emissions trading system

EU

European Union

MSR

Market stability reserve

EUA

EU allowancenEHS

EU ETS

European Emission Trading
SystemRGGINationales
Emissionshandelssystem(German national ETS)
Regional Greenhouse Gas
Initiative

EUR

Euro

ESR

Effort Sharing Regulation

FY

Fiscal year

GDP

Gross domestic product

GHG

Greenhouse gas

ICAPInternational Carbon Action
Partnership

JCM

Joint Crediting Mechanism

JI

Joint Implementation

ECOS Consult GmbH / adelphi consult GmbH

SME

Small and medium
enterprises

TMG

Tokyo Metropolitan
Government

TPE

Third-party entities

UN

United Nations

USD

US dollar

VRE

Variable renewable energy

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Factsheet „Experiences with Carbon Pricing in Germany, the EU and Japan”

1 Introduction
Climate change is the largest global threat of the 21st century. Increases in the concentration ofgreenhouse gas (GHG) in the world’s atmosphere have caused average global surface
temperature to rise by about one degree Celsius. Most of the warming has occurred in the last
40 years, with 2016 and 2020 the warmest years on record (NASA, 2021b, 2021a).
This accelerating change in global surface temperature has severe environmental consequencesthat threaten the world’s populations and economies. Partly irreversible physical changes canalready be seen, such as the disruption of seasonal events, sea-level rise, extreme weather,glacier retreat, and decreases in Arctic sea ice. Climate variability has also triggered forced
migrations, conflicts, pressure on freshwater supplies, negative consequences on human health,and food security risks. This phenomenon has also increased the gap between the rich and poor
(Diffenbaugh & Burke, 2019).
To halt temperature increases, net emissions must ultimately fall to zero such that any remaining
emissions are balanced by removals of carbon dioxide from the atmosphere. There is scientificand emerging political consensus that this must take place by 2050 to have a realistic chance of
maintaining temperature increases to 1.5 degrees Celsius (IPCC, 2018). Reflecting this urgency,
the Paris Agreement was adopted by 196 countries in 2015, with the goal to keep global averagetemperatures to “well below” 2 degrees Celsius, preferably to 1.5 degrees Celsius, above preindustrial levels. On top of this, 127 countries, including both Japan and Germany, havecommitted to net zero emissions targets by 2050 (CAT, 2020).
While the goal is clear, the pathway towards net zero is not. Various pathways have differing
environmental and economic tradeoffs that also diverge across regions and sectors (IPCC, 2018).
Carbon pricing, which harnesses the power of private actors in changing their production,
consumption, and investment decisions, is therefore an essential component of a broader
strategy in coordinating mitigation efforts in a way that ensures least cost.
Experience with carbon pricing is growing. Carbon prices have proven effective in driving both
mitigation (Burke et al. 2020; Marcu et al. 2020; Abrell et al. 2020) as well as contributing to low
carbon innovation (Grub et al., 2021; Calel & Dehezlepretre, 2016; Aghion et al., 2016). However,a challenge confronting all jurisdictions that consider carbon pricing is how to ensure a levelplaying field for carbon-intensive commodities that compete in international markets (Acworth
et al., 2020). In response to this challenge, there is growing interest in, for example in theEuropean Union and United States, the role of carbon border adjustment mechanisms (CBAM)
to level carbon costs at national borders.
The Japanese government has begun to review domestic carbon pricing and, in parallel, examine
Japan's border carbon adjustment strategies (Nakayabashi, 2021). Decarbonization of the power
and industrial sectors will be a key component of any carbon pricing policy for the country given
its emissions profile.

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Factsheet „Experiences with Carbon Pricing in Germany, the EU and Japan”

This factsheet aims to support the discussion on carbon pricing for the German-JapaneseEnvironmental and Energy Dialogue Forum (EEDF). It reviews the experience to date with carbon
pricing in Germany and Japan and places a spotlight on emerging trends in the industrial andpower generation sectors. The timing for such a discussion is opportune as Japan considers theimportant role of a carbon price in the policy mix and in the transition towards its net zero target.
The factsheet proceeds as follows: the first two sections outline the rationale for global carbon
pricing, lay out how jurisdictions have pioneered such policy approaches, and describe how thesehave recently proliferated around the world. The third and fourth sections cover the main
experiences with carbon pricing mechanisms in Europe, Germany, and Japan. Conclusions follow.

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Factsheet „Experiences with Carbon Pricing in Germany, the EU and Japan”

2 Carbon pricing design and diffusion
2.1 Why price carbon?
In its essence, carbon pricing aims to correct a market failure in that existing economic systems
do not value the climate damages associated with the release of GHG emissions. Through thislens, damages from climate change are not properly reflected in production and investment
decisions or consumer choices.
For producers, carbon pricing creates an incentive to incorporate the cost of GHG emissions into
operational decisions. GHG emissions are treated as an input with an associated cost and are
therefore managed accordingly. Companies are forced to restrict emissions in their processes,
make their goods less emissions-intensive, or make low-carbon investments. If declining
emissions caps are set for future periods, carbon pricing also gives visibility to future obligations
that may be relevant in decision-making about long-lived assets (Acworth et al., 2017).
For consumers, carbon pricing makes carbon-intensive goods and services more expensive,
thereby reducing their consumption. For investors, carbon pricing provides a financial incentive
to invest in low-carbon assets, including new products, processes, and technologies. High-carbon
assets are less attractive as they are less competitive, and risk being decommissioned before
capital costs have been recovered (standard assets). For innovators, a financial incentive iscreated to develop new products, processes, and less emissions-intensive technologies.1
The cost of combating climate change differs considerably across emission sources. By harnessing
the power of individual decision makers, carbon pricing ensures emission reductions are costeffective. A carbon price does not tell people what steps they need to take to minimize emissions.
Instead, people and firms decide how best to respond to this price. This means that carbon
pricing can accomplish further reductions at the same expense as other climate policies.
Flexibility is also provided surrounding when emission reductions take place, such that mitigation
can happen when it is cheapest.
Jurisdictions can choose the carbon pricing instrument that best suits their needs. In the first partof this section, we discuss the types of carbon pricing, address their similarities and differences,and see how these influence instrument design. The global diffusion of carbon pricing is thendiscussed.

2.2 Types of carbon pricing
It is possible to create an explicit carbon price directly through emissions trading or a carbon tax.
Regulations and standards produce an implicit carbon price. However, explicit pricing has
typically been found to be more cost-effective (IPCC, 2014). An emissions trading system (ETS)1This is consistent with the Hicksian theory of induced innovation, which suggests that changes in relative factor
prices should lead to innovations that reduce the need for the relatively expensive factor (Hicks, 1932).
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Factsheet „Experiences with Carbon Pricing in Germany, the EU and Japan”

is based on the principle of cap and trade. This instrument sets a cap on overall emissions in the
sectors covered by the system. To generate a unit of GHG, emitters must surrender an emission
allowance. Regulated companies can obtain, buy, or trade these, with the emerging allowance
price reflecting the underlying scarcity of allowances.
A carbon tax levies a price per ton of GHG emitted. Businesses covered by the tax are obliged to
pay this amount for every ton they emit. Governments consider how the tax will fit into thegeneral environment of the jurisdiction, as well as the context of energy and fiscal policy.
Increasingly, policymakers are implementing hybrid instruments that combine elements of each
instrument, as discussed below.
ETSs and carbon taxes share common ground: Both an ETS and a carbon tax impose a carbon
price, are cost-effective, and generate revenue (through allowance auctions under an ETS).
Carbon pricing revenues may be used to invest in environment and energy policy, fund tax
changes, repay government debt, sustain social services, or reimburse domestic customers (Hauget al., 2015).
Two roads, one destination: ETSs and carbon taxes are different in their treatment of
uncertainty, simplicity, and the flexibility they offer. An ETS determines the total amount ofemissions by setting a cap, ensuring the mitigation outcome. As a result, the price of carbon
fluctuates according to the demand for allowances. A carbon tax offers price stability but
provides less certainty over the level of mitigation achieved.2 To the extent that a carbon tax canbe integrated into the existing fiscal infrastructure, it is considered to be administratively easier
to implement than an ETS, which requires additional market infrastructure (Goulder & Parry,2008). However, an ETS provides more versatility. Provisions such as offsets and banking givecovered entities options for when and where to mitigate emissions. Finally, there is the ability to
expand the ETS by linking it with other programs across boundaries. Cooperating on carbon taxes
is possible, but more complex (Kreibich & Wang-Helmreich, 2017)
Tailor-made carbon pricing: The choice between an ETS and a carbon tax depends on the context
and needs of a particular jurisdiction. These two instruments are not mutually exclusive. Several
jurisdictions have complementary ETS and carbon taxes covering different sectors. As a first step
towards creating an ETS, some have introduced a carbon tax. Over time, hybrid approaches have
evolved that aim to combine the advantages of both instruments for a more effective andefficient outcome. For example, it is common for an ETS to also include price floors that provide
certainty regarding the lower bound of the carbon price, as well as an overall emissions constraint(Acworth et al., 2020). Further, carbon taxes can be designed to adjust periodically based on anassessment of the mitigation achieved (Metcalf, 2017). Conversely, offsets can provide flexibility
for covered entities under both a carbon tax and ETS and therefore offer a potential indirect link.

2

See Weitzman (1998) on policy choice under uncertainty.

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Factsheet „Experiences with Carbon Pricing in Germany, the EU and Japan”

Regardless of its nature, carbon pricing is a crucial mechanism for governments to minimize theemissions in their jurisdictions cost-effectively, with various design options.

2.3 Global diffusion of carbon pricing
As of 2019, 46 countries and 35 subnational jurisdictions on five continents directly price carbon,
covering over 12 GtCO2e and representing 22.3% of global GHG emissions (World bank, 2020a).
There are 63 initiatives implemented, of which 33 are ETSs, and 30 are carbon taxes (Doda &Ortiz Rivera, 2020). Carbon prices range from less than USD 1/tCO2e to USD 119/tCO2e, withalmost half of the regulated emissions priced below USD 10/tCO2e (see Appendix 1) (World Bank,
2020b). The cumulative value of carbon pricing initiatives alone was USD 45 billion in 2019 (World
Bank, 2020b). Systems work in a wide variety of jurisdictions, from mega-cities such as Tokyo, toUS states and Canadian provinces, as well as in supranational jurisdictions such as the European
Union (See Figure 1). The number of initiatives using carbon pricing has been increasing, goingfrom 37 in 2015 to 63 in 2019 (Table 1).
Year

Carbon Carbon Carbon
Markets Tax
Pricing2019 30

33

63

2018 2324

47

2017 2223

45

2016 2220

422015 17

20

37

Table 1: Carbon pricing initiatives. Count by year.
(Source: Global Carbon Pricing Initiatives Database, ICAP.)ECOS Consult GmbH / adelphi consult GmbH

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Factsheet „Experiences with Carbon Pricing in Germany, the EU and Japan”

Figure 1: Carbon pricing initiatives implemented or scheduled for implementation, with sectoral coverage and GHG
emissions covered
Source: World BankECOS Consult GmbH / adelphi consult GmbH

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Factsheet „Experiences with Carbon Pricing in Germany, the EU and Japan”

Each system implemented to date illustrates the flexibility of carbon pricing: Each program
implemented to date reflects its own carbon pricing approach, with design characteristics varying
depending on the different contexts. This means that the GHG and economic sectors coveredvary between different initiatives (Figure 1). Carbon pricing instruments can be built toaccommodate several political and economic conditions and go hand in hand with sustainableeconomic growth.
Carbon pricing is most common in the power and industrial sectors, although it has been
implemented or is under consideration in all sectors (ICAP, 2021). Several jurisdictions have
expanded the scope of their existing carbon pricing initiatives to include a higher number offacilities, sectors, and gases (World Bank, 2020b). Other modifications include the refinement ofallocation methodologies and linkage with other jurisdictions with ETSs in place. Cooperation
between jurisdictions, at all levels, continues to increase around the world (see Section 5.3).
New systems are emerging: Recently, Asia has become a hotspot for new ETS development. After
Kazakhstan in 2013, Korea and China introduced their national ETSs in 2015 and 2021
respectively. The instrument is also under development or consideration in for example Thailand,
Vietnam, Indonesia, and the Philippines. Elsewhere, interest in emissions trading has continued
at the state level in the US, with New Jersey, Virginia, and possibly other states preparing to enter
the RGGI market and others considering their own systems, such as Oregon. In Latin America, thestart of the pilot phase of Mexico’s ETS marked the beginning of emissions trading in the region(ICAP, 2021).

3 Experience with carbon pricing mechanisms in Germany and the EU
3.1 The EU ETSIn 1997, the Kyoto Protocol created, for the first time, legally binding goals for industrializedcountries to reduce emissions (UNFCCC, 1997). After the Protocol was signed by all EU Member
States, a period began aimed at exploring how to fulfill the commitment. The EU's job was to findan efficient way to set up a framework for enforcing the agreements signed on climate change
and reducing GHG emissions. The European Commission published a green paper on GHG
emissions trading within the EU in March 2000 with some initial thoughts on the European Union
Emissions Trading System (EU ETS) design. This served as the basis for various stakeholder
discussions, which helped form the basis of the EU ETS Directive and ultimately the start of the
EU ETS in 2005 (European Parliament, 2018).3
The EU ETS is a central pillar of the EU's climate change strategy and a crucial mechanism forcost-effectively reducing GHG emissions from the regulated sectors. The system covers
approximately 45% of emissions from energy, manufacturing, and intra-EEA aviation (flights
within the European Economic Area). The EU ETS has been linked to the Swiss ETS since January3

The provisions of the EU ETS Directive have been kept under review and changed since then.

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Factsheet „Experiences with Carbon Pricing in Germany, the EU and Japan”

2020, the first such link for both parties. The revision of the system's architecture, completed in2018, was introduced in January 2021 with the start of the fourth trading phase. The European
Commission is currently proposing to update and likely extend the EU ETS's reach to achieve a
climate-neutral EU by 2050 and the goal of a net reduction of at least 55% in GHG emissions by
2030.
The first phase of the EU ETS took place between 2005 and 2007 and was the pilot phase. This
phase was primarily focused on data gathering, learning, and built the appropriate infrastructure
for emissions monitoring, reporting, and verification (MRV).
The second phase ran from 2008 to 2012. This phase coincided with the first commitment periodof the Kyoto Protocol, where emissions reduction goals had to be met by the Member States.
Consistent with the flexibility provisions envisaged in the Kyoto Protocol, covered entities could
draw upon a fixed number of units generated through the Joint Implementation (JI) mechanism
as well as the Clean Development Mechanism (CDM), although in practice few credits were used.
A major learning from the second phase surrounded allocation. Allowances were predominately
granted free of charge, which resulted in large windfall profits to fossil fuel power generatorsthat were able to pass on the opportunity cost of the allowances to electricity prices.
The third phase ran from 2013 to 2020, with several adjustments based on the lessons of the firsttwo phases. These included:
•
•
•
•

•

•

The creation, through a single Union Registry, of a centralized system;
A single EU-wide emissions cap in place of the previous framework of national caps;
Auctioning as the default method for allocating allowances;
The inclusion of installations for carbon capture, transport, and storage. The productionof petrochemicals, ammonia, nonferrous and ferrous metals, gypsum, aluminum, as wellas nitric, adipic, and glyoxylic acid (various thresholds) was also included;
The establishment of a carbon leakage list that enabled installations in sectors considered
to be exposed to a risk of carbon leakage to obtain a higher proportion of the freeallowances; and300 million allowances set aside to support innovative renewable energy and carbon
capture and storage (CCS) technologies through the NER 300 initiative.

While from an operational perspective, the EU ETS performed well in its third phase, from amitigation perspective it was plagued by an oversupply of allowances that resulted from theeconomic crisis and the rapid inflow of credits. This surplus weighed heavily on the allowance
price that remained low for much of the eight-year period. Hence, policy discussions focused on
future reform options that would make the EU ETS more resilient to unforeseen exogenous
shocks. Ultimately a Market Stability Reserve (MSR) was implemented in 2019 that automaticallyadjusts auction volumes based on a measure of allowance surplus.
The fourth phase of the EU ETS will run from 2021 until 2030. Phase IV aims to increase the paceof emission reductions, create better-targeted rules on carbon leakage, and finance low-carbon
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Factsheet „Experiences with Carbon Pricing in Germany, the EU and Japan”

innovation and modernization of the energy sector. An additional reform to the system in Phase
IV is also under development. As governments around the world aim to keep pace with therequired emission reductions of the Paris Agreement, the European Commission is currently
preparing a proposal for further adjustments to the EU ETS. Known as the “Fit for 55% Package”
the European Commission is considering changes to the emissions cap and associated Linear
Reduction Factor (LRF); sectoral scope; rules around carbon leakage; and the parameters of the
MSR.
The EU Allowance (EUA) price has varied. As discussed above, Phase III saw a sustained period of
low prices associated with an imbalance between allowances supply and demand. However, as
the rules for Phase IV were adopted and the MSR began operation, prices have steadily risen.

Figure 2: EU ETS allowance price over time.
Source: ICAP Allowance Price Explorer

The EU ETS has proved to be a successful instrument for cost-effectively guiding emissions
reduction. Between 2005 and 2019, emissions from installations regulated by the ETS declined
by about 35% (European Commission, 2020). Higher allowance prices have converged with lower
gas prices to ensure that the EU ETS has contributed significantly to fuel switching in recent years(Abrell et al., 2020; Marcu et al., 2019). Since 2009, the EU ETS has cumulatively raised over USD
80 billion (ICAP, 2020). These revenues have been funneled back into projects related to energy
efficiency, renewable energies, low-carbon innovation, research into carbon storage and capture
technologies, and GHG reduction programs. The EU ETS has also had a modest effect on
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Factsheet „Experiences with Carbon Pricing in Germany, the EU and Japan”

investments and innovation (Lilliestam et al., 2021), although this mitigation lever is expected toplay a stronger role with higher and more stable allowance prices in Phase IV. For an overview
of key policy changes, see Annex 2.

3.2 The German Fuels ETS
In 2021, Germany launched its National Emissions Trading System (in German: Nationales
Emissionshandelssystem, or nEHS) for heating and transportation fuels. This measurecomplements the EU ETS and forms a key part of Germany’s ‘Climate Action Programme 2030’,
which sets out the steps necessary to meet Germany's 2030 climate goals and achieve climate
neutrality by 2050. The implementing legislation for the nEHS is the ‘Fuel Emissions Trading Act’
that was adopted in December 2019 and amended in November 2020. Combined with the EU
ETS for the power, industry and aviation sectors, the nEHS ensures that most of Germany's
emissions will face a carbon price from 2021 onwards (ICAP, 2021).
The nEHS will be phased in from 2021 to 2025, with an annually increasing fixed price per tCO2.
In 2026, a price corridor will apply, and in 2025, it will be determined if a price corridor will be
introduced from 2027 onwards as well. Fuel coverage will also be gradually extended between
2021 and 2023.
The nEHS and the EU ETS have different approaches to reducing GHG emissions (DEHSt, 2020).
The EU ETS requires emissions reporting and surrendering of allowances at the source whereemissions are produced in installations such as power plants (downstream). The nEHS on theother hand covers emissions at a much earlier stage when the fuels enter the market and before
they reach the plant (upstream). That means that the emissions that arise from the fuels’
subsequent combustion are traced back to the distributor.
The nEHS includes all fuel distributors and suppliers and applies to all fuels used in the transport
sector and for heat production (e.g., fuel oil, LPG, natural gas, coal, gasoline, and diesel). In
general, biomass used as fuel in the transport sector and for heating purposes is also covered.
However, biogenic fuel emissions that meet the sustainability requirements set out in thenational regulations transposing the European Renewable Energy Directives 2029/28/EC and2018/2001 are not subject to compliance obligations. In 2021 and 2022, the system will begin
with a restricted scope, including fuel oil, LPG, natural gas, gasoline, and diesel. Other fuels suchas coal will be covered from 2023 onwards.
The cap will be set annually based on a Cap Setting Regulation to be implemented in 2021. In
essence, the cap will be calculated in line with Germany's reduction targets for non-EU ETS
sectors as specified in the European Effort Sharing Regulation (ESR). However, if emissions andthus demand for allowances within the nEHS exceed its cap, additional allowances would bemade available , drawing from the flexibility mechanisms provided for in the ESR, , including thetransfer of additional emission reductions under sectors not covered by the nEHS to the system,or the acquisition of annual emission allocations from the other EU Member States. The flexibility

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Factsheet „Experiences with Carbon Pricing in Germany, the EU and Japan”

described above leads to a flexible cap, which will be implemented during the fixed price phaseand as long as a price cap is considered necessary. As soon as the fixed prices are lifted and pricesetting is left to the market alone, the cap will be absolute.
All allowances will be sold between 2021 and 2025 for a fixed price that starts at EUR 25 per tCO2
in 2021 and increases annually to EUR 55 per tCO2 by 2025. The steady rise in the price of CO2
strengthens the incentive to minimize or eradicate the combustion of fossil fuels over time. The
price will not be paid by those who use the fuel and generate CO2 emissions but rather by thefuel suppliers. However, it is anticipated that the suppliers will pass the carbon costs on to theircustomers so that, at the end of the supply chain, the consumers of the fuels will be paying fortheir emissions. Figure 4 provides an estimate for how fuel costs are expected to evolve. The
auctioning of allowances begins in 2026, and there will be a price corridor with a minimum priceof EUR 55 and a maximum price of EUR 65 per tCO2. Based on a system review in 2025, it will be
determined if a price corridor will continue to be implemented from 2027 onwards.

Figure 3: 2021-2026 Price trend
Source: DEHSt (2020)

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Factsheet „Experiences with Carbon Pricing in Germany, the EU and Japan”

Gradual increase in prices for selected fuels
16
14

euro cents

12
10
8
6
4
2
0
2021

2022

Natural gas (kWh)2023
Premium Petrol (l)2024Diesel (l)2025Light fuel oil (l)Figure 4: Gradual increase in prices for selected fuels
Source: DEHSt (2020)

To ensure the competitiveness of entities covered by the nEHS a financial compensation
mechanism will be established to avoid the relocation of companies and their emissions abroad asa result of the additional fuel costs (carbon leakage). The mechanism will apply to companies fromemissions-intensive and trade-exposed (EITE) sectors that operate internationally and will comeinto effect as early as 1 January 2021. Respective regulations will be released by mid-2021 andwill have retroactive effect.

4 Experiences with carbon pricing mechanisms in Japan
4.1 National level: JVETS, JCM, and recent developments
Discussions on the introduction of carbon pricing mechanisms on a national level have beenongoing in Japan for more than ten years. The Ministry of the Environment, Japan (MoEJ) was
the first authority to launch a national carbon pricing mechanism in 2005 (Voluntary Emission
Trading Scheme (JVETS), see Section 4.1.1), with the aim to accumulate knowledge andexperience in cap and trade. In his “Fukuda Vision” in 2008, former Prime Minister Takeo Fukuda
mentioned the experimental introduction of an integrated domestic market for emissions
trading, although this was not initially intended as a precursor to the future introduction of amandatory ETS. He also gave the instruction to relevant ministries to proceed with concrete
discussions on this matter (Nikkei Newspaper, 2019; The Japan Research Institute 2008). After
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the change of government, former Prime Minister Yukio Hatoyama declared in a speech at the2009 UN Summit on Climate Change in New York that Japan would introduce a domestic
emissions trading mechanism (Asahi Newspaper, 2009).
The Japan Business Federation Keidanren soon raised objections regarding the introduction of amandatory ETS by pointing out that strengthening carbon pricing measures would lead to adepression of economic activities and a decrease in international competitiveness due to risingenergy costs. Moreover, they insisted that private sector innovation – necessary for long-termclimate mitigation – would be inhibited (Keidanren, 2019). Keidanren established its own
Voluntary Action Plan, Plan in 1997, where each industrial sector sets its own reduction target(Keidanren, 2014). For small- and medium-sized enterprises (SMEs) not covered by the Action
Plan, the government established a Domestic Credit Scheme in 2008. Keidanren also stated in2012 that the government should support the Low-Carbon Society Implementation Plan byIndustry and that it is necessary to accelerate negotiations with developing countries for bilateral
offset mechanisms to promote overseas contributions through Japanese technology (Keidanren,2014). Under pressure from these domestic voices, the MoEJ was not in the position to introduce
a nation-wide mandatory ETS.
However, political framework conditions have changed since newly elected Prime Minister
Yoshihide Suga pledged to bring Japan to net zero emissions by 2050 in his policy speech in
October 2020 (Nikkei Asia, 2020); this breathed life into a debate that has lain relatively dormant
for many years (see Section 4.1.3).
The steps and milestones regarding the development of a domestic ETS in Japan are outlined
below and described in the following sections.
Apr 2005 Mar 2013

Japan Voluntary Emission Trading Scheme (JVETS) introduced by MoEJ
designed to gain experience in cap and trade and voluntary GHG reductions

Jan 2008

Advisory Committee on the Emissions Trading Scheme established by MoEJ-

Jun 2008

Published an interim report in May 2008, with discussion points and four
scheme options for cap and trade
Declaration of “Fukuda Vision”

Oct 2008

Experimental introduction of an integrated domestic market for emissions
trading and Domestic Credit Scheme

Nov 2008

Offset Credits (J-VER), MoEJ-

Sep 2009
Mar 2010

Verify emissions reductions and removals by SMEs, agriculture, andforestry as reliable credits for market transactions
PM Hatoyama’s Declaration at the UN Summit on Climate Change, New YorkBill for the Basic Act on Climate Change Countermeasures (cabinet decision
12 Mar 2010, passed by the Lower House 18 May)ECOS Consult GmbH / adelphi consult GmbH

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Apr - Dec2010
Dec 2010

Domestic Emission Trading Subcommittee, Central Environment Council-

Based on the Bill for the Basic Act, contributing to the scheme design byanalyzing various discussion points
Discussion on three major policies (carbon tax, ETS and feed-in-tariff forrenewable energy) to counter climate change, ministerial meeting on theissue of global warming- Request for careful consideration on emissions trading

Oct 2012

Introduction of Tax for Global Warming Countermeasures2013

Launch of J-Credit scheme

2016

Japan’s official General Plan for Global Warming Prevention released

2019Long-Term Strategy under the Paris Agreement as growth strategy

Feb 2021

Working group for discussion on carbon pricing is planned to be established

Table 2: Progress of ETS related measures in Japan(Source: ECOS based on MoEJ, April 2012, “Consideration of Emissions Trading Scheme in Japan” UNFCCC, 24 June2019” Japan’s current progress of GHG reduction” and MoEJ, 2012, “Details on the Carbon Tax”)

4.1.1 JVETS
The Voluntary Emission Trading Scheme (JVETS) was introduced by the MoEJ in 2005 with theaim to accumulate knowledge and experience in cap and trade. The basic scheme andinfrastructure were similar to the operational system of the ETS in the EU. The scheme was inoperation from 2005 to 2013 for seven phases with 389 participating entities (MoEJ, 2014). The
initial pledged estimated amount of CO2 reductions was 1.25 Mt; final results of the program
showed 2.22 Mt of reductions (MoEJ, 2014).
The JVETS provided valuable learnings with regards to MRV. A lack of clear guidance in the initial
phase resulted in a diversity of procedures and calculation methods across installations andverifiers, which created some confusion. To address this, the MoEJ released a guideline formonitoring and reporting in the second phase. In the third phase, the verification line was revisedin accordance with ISO 14064-3, an international standard for validation and verification (MoEJ,
2014).
For promoting further emissions reduction, the MoEJ additionally established the J-VER Scheme
in 2008, a verification scheme for credits generated through GHG reductions carried out bydomestic projects. Participants in the JVETS constituted a part of Experimental Integrated ETS
which began in 2008 (MoEJ, 2011; see Section 4.1).
In 2013, the J-Credit scheme was created by integrating the Domestic Credit Scheme and the JVER. Under this scheme, the central government certifies the amount of GHG reductions byenergy-saving devices and managing forests, as credit. The scheme is still running today with 832
projects in total (J-Credit, 2020). The benefits of the scheme include not only achieving CO2
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selling credits. Being able to signal sustainability is another attractive aspect for businesses. For
large-scale enterprises that consume more energy and emit more CO2 in general, the scheme canbe used to achieve Voluntary Action Plan targets by reporting adjusted emission amounts. Thereis no limitation for project participants under the J-Credit scheme (J-Credit, 2020).

Figure 5: Process of J-Credit(Source: J-Credit Scheme, June 2020

“Outline of J-Credit Scheme”: https://japancredit.go.jp/english/ )4.1.2 Joint Crediting Mechanism (JCM)
To contribute to the sustainable development of developing countries, the Japanese government
set up the Joint Crediting Mechanism (JCM) in 2011. The JCM implements mitigation actions indeveloping countries to help achieve Japan’s own targets. A Joint Committee consisting ofrepresentatives of both the Japanese and the implementing country’s governments develops
rules and guidelines necessary for the implementation of the scheme, approves the proposed
methodologies, and designates third-party entities (TPE) (Government of Japan, 2019). The
Committee then decides on whether to register JCM projects validated by the TPEs. Based on
notification for issuance of credits by the Joint Committee, each government issues the notified
number of credits to its registry.
Partnership documents have been signed with 17 countries, including countries in Asia, Africa,
Small Island Developing States (SIDS), Latin America and the Middle East (Ministry of Foreign
Affairs, 2019). As of December 2020, 174 projects with those countries are in operation (MoEJ,2020). The estimated emission reductions by 2030 through JCM programs range from 50 to 100
Mt CO2 (Government of Japan, 2019).

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Funding for the JCM is currently provided mostly by the Japanese government. Each partnercountry develops its own methodology, and this complicated system can hinder the active
participation and efforts on business development of private entities in this scheme. The longterm prospect of the scheme is also uncertain.

Figure 6: JCM Procedures(Source: The Joint Crediting Mechanism, 2021, “Overview of the Joint Crediting Mechanism”:
http://gec.jp/jcm/about/)

4.1.3 Tax for Global Warming Countermeasures
A tax for Global Warming Countermeasures was implemented gradually in Japan from October
2012 and reached the originally planned tax rate in April 2016. It covers the use of all the fossil
fuels such as oil, natural gas, and coal. The tax rate per unit quantity (kL or tonne) is set in orderthat the tax burden is equal to JPY 289 (USD 2.75) per tCO2 emissions and added above to thepetroleum and coal tax. Compared with other countries, the rate is still very low. Revenues fromthis tax are channeled to renewable energy, low-carbon technologies, and energy-saving
measures and equipment. In 2021, working groups on carbon pricing will continue discussions
on the future shape of this tax (Government of Japan, 2021; World Bank, 2020).

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Figure 7: Tax for Climate Change Mitigation (Source: MoEJ, 2012, “Details on the Carbon Tax”:
https://www.env.go.jp/en/policy/tax/env-tax/20121001a_dct.pdf)

4.1.4 Recent developments
Some momentum has come into the discussion on a nation-wide carbon pricing policy afterPrime Minister Suga announced a 2050 net zero pledge in October 2020. Already in December
2020, Prime Minister Suga instructed the Ministry of Environment, Trade and Industry (METI) andthe MoEJ to begin coordinating on carbon pricing. METI has announced that it is now starting theprocess for the potential introduction of carbon pricing (Nikkei Newspaper, 2021). A related
working group is planned to be established in mid-February 2021; MoEJ will join as observer. It
is expected that various political options including a carbon tax or ETS will be discussed here.
In the beginning of February 2021, the MoEJ resumed a talk on carbon pricing with experts after
a one-and-a- half year hiatus (NHK, 2020). The panel discussed the characteristics and problems
of establishing an ETS and hopes to conclude its opinions by end of the year. The chairperson of
Keidanren also showed his intention to discuss the issue positively and will consider and proposea “realistic” plan (NHK, 2021).

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4.2 Subnational level: Tokyo and Saitama
4.2.1 Tokyo Metropolitan Government
Almost 14 million people (as of November 2020) are living (TMG, 2020) in the capital city of Japan,
and it generates approximately one fifth of Japan’s GDP. The metropolis emitted 63.9 Mt CO2 in2018, which is approximately 5% of Japans total GHGs (TMG, 2020). In 2008, the Tokyo
Metropolitan Government (TMG) announced the new Environmental Master Plan, which
includes the goal of reducing emissions by 25% compared to 2000 by 2020 (TMG, 2008). The
revised regulations for the enforcement of the Tokyo Metropolitan Environmental Security
Ordinance in March 2020 include a decision on the cap for the third compliance period (FY2020FY2024) of the Tokyo Cap-and-Trade Program and set the more ambitious goal to reduce energy
consumption by 38% and GHG reduction by 30% in 2030 (TMG, 2020).
Against this backdrop, Japan’s first subnational mandatory ETS was launched by the Tokyo
Metropolitan Government in 2010, following related government measures as outlined below.
2000 Launch of the Carbon Emissions Reduction Programme
2002 Launch of Green Building Programme2005 Revision of the Carbon Emissions Reduction Programme and launch of Phase II
2006 Announcement of GHG emission reduction target of 25% by 2020 relative to 2000
levels2007 Approval of Tokyo Climate Change Strategy and Tokyo Metropolitan
Environmental Master Plan
2008 Tokyo Metropolitan Environment Security Ordinance amended to officiallyestablish the Tokyo ETS
2010 Official launch of Tokyo ETS
Table 3: Brief history of ETS development by the Tokyo Metropolitan Government(Source: CDC Climate Research, EDF and IETA, May 2015, “Tokyo The World’s Carbon Markets: A Case Study Guide
to Emissions Trading”: http://www.edf.org/sites/default/files/tokyo-case-study-may2015

The Tokyo ETS covers large-scale facilities from the industrial and commercial sectors that
consume fuel and heating equivalent to at least 1,500kL per year. These accounts for almost 40%of the total emissions of the city. The first compliance period ran from 2010 to 2014, and thesecond from 2015 to 2019 (TMG, 2010). In FY2018, emissions from participating facilities
amounted to 12.11 Mt CO2, achieving a 27% reduction from baseline emissions (16.5 Mt).

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Figure 8: Amount of CO2 reduction from 2015FY to 2019FY(Source: Based on TMG press release on 26. March 2020, “Tokyo Cap and Trade, the result of the fourth year of
the second phase”:
https://www.kankyo.metro.tokyo.lg.jp/climate/large_scale/data/index.files/CapandTrade2018result_J.pdf)

When the Tokyo ETS was first introduced, it was met with opposition from several industries. 15
industry federations including Keidanren submitted a request document to the TMG, in which
five problems were listed as serious concerns: 1) the regulatory measure was too strong, 2) it
prevented competition between companies, 3) it went against national and global climate policy,4) it hindered innovation, and 5) it inhibited the vitality of the city (REI, 2017). Keidanren statedin a public comment in 2018 that (Keidanren, 2018):•

The Tokyo ETS creates a managerial burden on businesses and large-scale office owners;•

Despite the work of the "Study Group on Specialized Matters for Implementation of
Reduction Obligations", it is unlikely that a system was in place that could fully reflect theopinions of the participating businesses; and•The opinions of the participating businesses should be taken into consideration as much as
possible in the making of important decisions regarding the ETS.

Despite the concerns of the industry, Tokyo’s economy has grown continuously after the
introduction of the ETS. According to a survey for participating entities, more than 70% werewilling to install high performance equipment. Moreover, 7% of entities were nominated as “toplevel facilities”, a label awarded to facilities (including buildings and factories) with high energysaving performance (TMG, 2015).

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4.2.2 Saitama Prefecture
Saitama Prefecture began its efforts on climate policy with the ‘Eco-Up System’ in 2002: theprefecture grants certification to business entities contributing voluntarily to emission
reductions. The targeted group includes private enterprises consuming more than 1,500kL
energy equivalent and with an area exceeding 10,000m2. In this scheme, however, thecompliance deadlines as well as the targeted reduction amounts are decided by the entities
themselves. Therefore, participating entities accounted only for one quarter of the total
emissions in the prefecture (Hamamoto, 2020). Against this backdrop, Saitama’s ETS wasestablished in April 2011 as part of the ‘Saitama Prefecture Global Warming Strategy Promotion
Ordinance’, consisting of three compliance periods (FY2011-FY2014, FY2015-FY2019, andFY2020-FY2024).
Based on the amount of 42.96 Mt CO2 emissions in FY2005, the prefecture aimed to reach a total
CO2 reduction of 21% by 2020. Under the ETS, large buildings and factories in Saitama wererequired to reduce emissions by 15% or 13% in its second compliance period as compared to thebaseline.4 Tokyo and Saitama have since signed a linking agreement, allowing credits to be traded
across the systems of the two jurisdictions.
In FY2018, the Saitama ETS achieved a reduction of 29% below base-year emissions (Nikkei
Newspaper, 2020) of large facilities. In August 2019, the prefecture announced targets for thethird compliance period (FY2020-FY2024), which requires facilities to reduce emissions by 22%
or 20% depending on their category (ICAP, 2020).

5 Current carbon pricing debates
5.1 Industrial decarbonization
The industrial sector makes up a large share of many economies around the world and emits
significant amounts of GHGs. In 2016, the production of basic materials alone made up
approximately 22% of total global CO2 emissions (Bataille, 2019). Unless the sector candecarbonize swiftly and significantly, achieving targets of net zero or the 1.5-2 degrees of theParis Agreement by 2050 will be difficult.
The industrial sector has been included in the EU ETS since its inception but has seen fewer
reductions in emissions intensity compared to the power sector (Neuhoff et al., 2018; Le Quereet al., 2018; Marcu et al., 2019; Marcu et al., 2020). There are numerous challenges when it
comes to industrial decarbonization. Growing global demand stands in contrast to the higher
costs of abatement of basic materials (such as iron and steel, cement, ammonia, and plastics),
carbon leakage concerns, and a lack of attention and funding directed to R&D strategies (IEA,
4

Basic level is calculated from average emission of three consecutive years from FY2002 to FY2007. For newparticipants, average rate from 4 FY in advance to the last FY before the beginning of the program or calculating
rate by using emission standard intensity.
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2019). Moreover, abatement options are limited compared to other sectors, given the very highheat requirements for the production of basic materials; the large amount of process emissions
that result from the chemical transformations that take place when raw minerals are converted
to materials; and the emissions that are embedded within the materials themselves (Material
Economics, 2019). These factors, among others, have resulted in less decarbonization progress
than in other sectors.
Deep decarbonization in the industrial sectors will require pushes from both the supply anddemand side. Opportunities for mitigation include, for supply: fuel switching, increased
efficiency, and technological innovation in production; and for demand: substitution to lowcarbon materials and products as well as improved product design (Acworth et al., 2020; Neuhoff
et al., 2018; Material Economics, 2018; ETC, 2018). Carbon pricing in the industrial sectors canfunction across the aforementioned levers: changing production and consumption behaviors andspurring innovation and investment, channeling these into less carbon-intensive alternatives.
However, many industrial sectors are emissions-intensive and trade-exposed (EITE). A carbon
price increases the cost of production for firms. Limited abatement options for many sectors
combine with the inability to pass costs down the value chain to consumers due to risks of a lossof competitiveness, as producers in regions without a carbon pricing policy in place continue
operation without these increased costs (Berger, 2008). This results in the risk of carbon leakage
or deindustrialization, whereby EITE firms may choose to shift production and investment
outside of the covered jurisdiction to keep costs down or lose market share domestically tocompetitors that face fewer constraints on emissions (Arlinghaus, 2015).
Currently, the free allocation of allowances is one approach to leakage protection being used bymany ETSs around the world (ICAP, 2020). Sectors assessed as being EITE can be eligible for freeallocation, which is useful in protecting their competitiveness but limits incentives for mitigation
beyond incremental production efficiency (e.g., through the use of benchmarks). However, as
ETSs become more ambitious on the pathway to net zero, with declining allowance caps andgreater auctioning, allowances available to be handed out for free will also decline, especially insystems with narrower sectoral scopes (Acworth et al., 2020). EITE sectors will face increasing
carbon costs and leakage risk unless their mitigation keeps pace with the phase-out of freeallocation (ibid).
Various reforms and companion policies are currently under discussion to ensure carbon pricing
can drive deep industrial decarbonization. The first of these, of particular prominence in the EU
context, are carbon border adjustment mechanisms (CBAM). To level the playing field between
firms covered by a carbon price and competitors operating from beyond the borders of thecovered jurisdiction, tariffs or other fiscal measures can be applied to imported goods based on
their embedded GHG emissions (Mehling et al., 2017). Similarly, rebates can be applied todomestic exports headed to markets without a comparably stringent carbon price. Talks on
CBAM, however, suffer several obstacles. Legal questions of compatibility with World Trade
Organization rules; administrative feasibility such as the availability of and access to emissions
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data especially from trade partners; and political sensitivities all play a role in the current debate(Marcu et al., 2020).
Another lever through which carbon pricing can spur decarbonization is innovation, whereby the
carbon price serves as a financial incentive to invest in the development and deployment of lesscarbon-intensive industrial products and processes to replace currently high-emitting goods andpractices. However, as outlined in Section 1, without a sufficiently high level and stable forward
trajectory, carbon pricing alone cannot be the only driver of industrial innovation. Innovation
itself suffers from multiple market failures, including the spillover effects from when positive
externalities from technological advances are not included in the rewards for eco-innovators,
leading to under-investment in R&D. Underinvestment in deployment may arise due to highcapital costs, limited demand for low-carbon industrial goods, uncertain carbon pricetrajectories, and the lock-in of incumbent technologies. These challenges must therefore be
addressed by a comprehensive package of companion policies (Neuhoff et al., 2017; Chiappinelli
et al., 2018).
Dedicated funding programs are one such policy that work in tandem with carbon pricing (Fischer
et al., 2014). Under the EU Innovation Fund, for example, revenues from the EU ETS are funneleddirectly back into piloting innovative technologies, with the aim to bring low-carbon industrial
solutions to a stage of readiness for deployment. Other instruments include subsidies forabatement technologies either via direct transfers or expenditure refunding to compensate
companies’ costs as they work to mitigate emissions. Carbon contracts for difference (CCfD) areanother supporting policy that can help to alleviate the risk that innovative technologies become
unprofitable in the future due to low carbon prices (Richstein, 2017). In essence, these arecontracts between a government and a firm developing a low-carbon project. Carbon costs areguaranteed for the duration of the contract and are based on a reference price, such as theallowance price. If the reference price is lower than the agreed contract price, the difference ispaid by the government, and vice versa. CCfDs stabilize future cost-saving environments, cancreate lead markets for low-carbon processes and materials, and help bridge the gap between
R&D/piloting and deployment and commercialization.

5.2 Electricity sector decarbonization
Experience with carbon pricing to date demonstrates that it can be a powerful tool todecarbonize competitive electricity sectors. By including the cost of GHG emissions into thevariable costs of electricity production, a carbon price has a number affects. First, it encourages
fossil fuel-based electricity producers to increase their efficiency or switch to low carbon
generation technologies. Second, it makes high carbon generation less competitive in wholesalemarkets, meaning they operate less and earn lower margins. The opposite is true for low carbon
generators that enjoy a higher market share and increased margins. Finally, allowance costs arereflected in electricity prices paid by consumers, encouraging them to conserve electricity
through energy efficiency investments and behavioral change (Acworth et al., 2019).
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CO2 emissions from the European power sector have decreased by an estimated 36.6% since2005, driving down the carbon intensity of power production by 35% (Marcu et al., 2020). The
decrease in the sector’s verified emissions in recent years results from significant improvementsin the fuel mix (EEA, 2020b). The EU-285 production of electricity from hard coal, lignite, andnuclear power decreased by 47%, 15%, and 17%, respectively, between 2005 and 2018 (Figure11). These decreases in electricity production were accommodated by an increase over the same
period in the gross generation of electricity from renewables such as wind, solar, and biomass.

Figure 9. CO2 emissions from the power sector and carbon intensity of power generation (2005-2019)
Source: Marcu et al. (2020); ERCST and BloombergNEF, data from Eurostat (2020) and EUTL (2020)

Figure 10: Drivers of GHG emissions variations in the power sector in the EU (2005-2018)
Source: Marcu et al. (2020); I4CE, data from Eurostat (2020)

There is little doubt the EU ETS has contributed to declining emissions from the European power
sector. However, given the complex interaction of supporting policies such as support for
renewable energy through the Renewable Energy Directive and national coal phase out policies,
the precise effect is difficult to assess. Quantitative analysis of the contribution of the various
factors to the variance in energy sector emissions reveals that the introduction of renewable5

Now EU-27 after the departure of the UK from the EU post-Brexit in 2020.

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energy sources was the most significant factor in reducing CO2 emissions from the power sector
over the period 2005-2018, equivalent to a 361 Mt reduction in CO2 emissions (Marcu et al.,2020). That said, with increasing allowance prices and favorable gas prices, the EU ETS is also
becoming an increasingly important factor in driving fuel switching from coal to gas. Examining
the German and UK contexts, Gugler et al. (2021) show that in the power sector, even a modest
carbon price can trigger substantial abatement at low cost so long as gas plants are available as
an alternative to coal. Their study also points to the greater impact of carbon pricing on inducing
abatement as compared to subsidizing wind or solar (ibid).
The EU ETS is also considered to have played a key role in the decarbonization of the UK power
sector, where since 2013 the allowance price has been supported by a top up fee that guarantees
a minimum carbon price for UK power generators (ICAP & PMR, 2020).6 The resulting carbon
price was identified as the main driver for the shift in generation away from coal, reducing its
share in UK electricity generation from about 35% in 2013 to about 5% in 2018 (DUKES, 2019).
EU ETS and power sector companion policies
The degree to which the reduction in emissions and the decrease in carbon intensity have been
induced by the EU ETS, by improvements in output and investment levels, or by other policies'
incentives is uncertain (Marcu et al., 2020). Indeed, there are other initiatives, some directly
aimed at reducing GHG emissions, others aimed at achieving other objectives (such as theimplementation of renewable energy sources and energy efficiency improvements) that cancontribute to emission reductions in the EU ETS sectors. National policies may also influence thefunctioning of the EU ETS at the level of the Member States. Figure 11 provides an overview ofEU-level policies that influence the functioning of the EU ETS.

6

The price floor was reached through the introduction of a Carbon Price Support (CPS). The CPS is an additional
carbon tax levied on all companies that use gas (supplied by a gas utility), LPG or coal, and other solid fossil fuels to
produce electricity. Instead of functioning as a reserve price at auction, the CPS is paid on top of EU ETS allowance
rates to ensure that the carbon price hits the minimum national target. The CPS shall be paid by organizations foreach emissions unit and added to any allowance costs. When allowances are surrendered, the obligation to pay
the CPS applies.
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Figure 11: Landscape of climate and energy policies
Source: Marcu et al. (2020); I4CE and Enerdata (2018) based on a visual concept of Ecologic

Given the uncertain impact of companion policies on emission levels and therefore the market
for allowances, it is now common place for ETSs to include measures for market stability that
automatically adjust the market in response to quantity or price triggers (PMR & ICAP, 2020). As
discussed above, since 2019 a MSR has been operating in the EU ETS. Other systems notable inNorth America have opted for a reserve price at auction (Acworth et al. 2019). The design andfunction of the MSR considering coal phase out policies and broader European climate objectives
as set out in the European Green Deal are to be an important aspect of the upcoming reforms.
Emerging challenges
Renewable energies are transforming the economics of the power industry (Egenhofer &Gazzoletti, 2019). Electrification is recognized as a least-cost decarbonization option. The lowcarbon transition will begin to expand deeper into the mobility, energy-intensive, and gas
markets. This will require reliable and inexpensive low-carbon electricity at huge volumes. It isestimated that around 65-70% of electricity generation, from renewables and nuclear combined,
will have zero marginal costs by 2030 (Egenhofer & Gazzoletti, 2019). The EU will draw on its
2020 strategy achievements, but there will be new and more significant obstacles in the period
from 2020 to 2030.
There are growing concerns that the electricity market architecture will not reward the required
flexibility to operate a system with large shares of variable renewable energy (VRE) or sufficiently
remunerate investments where prices are likely to remain low for prolonged periods of time
(Egenhofer & Gazzoletti, 2019). With regard to the role of carbon pricing, even with increasing
allowances prices, the impact on electricity prices will be muted when zero carbon generators
are setting the marginal cost of electricity. To deliver a safe, low-carbon generation mix at
reasonable cost, it is crucial to ensure efficient investment market signals (Egenhofer &Gazzoletti, 2019). Reforms that seek to reward flexible electricity supply, harness the
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responsiveness of demand, and send long term remuneration signals, will likely be discussed in
the coming years. This could require new thinking surrounding what role the carbon price willplay in continuing the push towards a net zero electricity system.
Finally, the diffusion of carbon pricing into regions outside of Europe that operate with various
types of market structure and regulations will face different opportunities and challenges. The
structure of the electricity system in terms of the power mix, availability and cost of renewables
and the age and ownership of the existing fossil based assets will impact the role of a carbon
price in the low carbon transition (Acworth et al., 2019).

5.3 Cooperation and linking
The effects of climate change are not demarcated by jurisdictional borders; neither do carbon
pricing instruments have to be constrained in this way. By cooperating internationally,
jurisdictions can work towards harmonizing carbon prices thereby reducing the risk of carbon
leakage and allow for greater climate ambition (Haug et al., 2015).
A key advantage of ETSs is that they can be linked to form larger, more liquid carbon markets.
Under linked systems, covered entities in one system have the option to use allowances from theother ETS to meet their compliance obligations, and to trade across the two (or more) (ICAP,2018). Linking can take various shapes, as shown in Figure 12 below. Unilateral linking allows
covered entities in System A to buy allowances from System B, but not vice versa. Bilateral linking
allows the two-way flow of allowances. Indirect linking can occur via other market mechanisms
if two systems are both linked to, for example, the CDM, but not each other (ibid).

Figure 12: Different types of linking
Source: ICAP (2018)

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Although there are of course challenges involved when establishing a link between systems, suchas ensuring the compatibility of ETS design features and policymaker sensitivities regarding thesovereignty of managing a joint market (Green et al., 2014), cooperation in this way has many
benefits. Linking increases access to more and potentially cheaper emissions reduction options,making room for more cost-effective and greater climate ambition (Edenhofer et al., 2007).
Linking also reduces concerns of competitiveness (Burtraw et al., 2013). As prices in linked
systems converge, covered entities are all subject to the same carbon price. Furthermore, linking
increases the number of market participants, improving trading efficiency and making the market
more resilient to external shocks (Flachsland et al., 2009). Finally, linking is a concrete example
of international cooperation and is an opportunity for jurisdictions to exercise climate diplomacy
and leadership (ICAP, 2018).
In Japan, the Tokyo Cap-and-Trade Program has been linked to the Saitama Prefecture ETS since2011. Other prominent examples of linkages around the world include California and Quebec(since 2014), Switzerland and the EU (since 2020), and the currently eleven states that make up
the Regional Greenhouse Gas Initiative (RGGI) in the US (since 2008).
Cooperation is also possible in the context of a carbon tax. Unlike when ETSs are linked with eachother and carbon prices converge through a market alone, connecting a fixed price carbon tax
with a flexible price ETS requires political coordination (Haug et al., 2015). This kind of linking cantake several forms: jurisdictions can exchange units directly, indirectly via offsets, one-way, or
two-way (Bodansky et al., 2014; Metcalf & Weißbach, 2010). For instance, tradable units can beincorporated into a carbon tax design, where entities can pay above their compliance obligation
and receive carbon tax credits in return. These could then be traded within the tax regime oracross system boundaries, such as with an ETS (although quantitative limits may have to be
imposed to safeguard the system’s emissions cap), or across borders (Haug et al., 2015).
Ultimately, linking between carbon taxes or across heterogeneous carbon pricing instruments
requires sustained political engagement in order to achieve comparable carbon prices (ibid).

6 Conclusions
Given Japan’s emissions profile, recently announced net zero targets, and economic and politicalstanding on the world stage, climate ambition and reducing emissions are matters of increasingly
high priority. In this regard, carbon pricing has proven to be an effective tool in steering costoptimal decarbonization pathways in Europe. By pricing emissions and aligning profits with low
carbon production, investments and consumption, a well-designed carbon price can significantly
contribute to Japan’s net zero goal. However, carbon pricing alone cannot drive deep
decarbonization across the board. Cumulative experience from around the world suggests that a
price on carbon must be embedded in a longer term, low-carbon policy framework in order tosuccessfully achieve its purpose of mitigation. In particular, Europe and Germany's experience
provides excellent lessons on the crucial influence of the energy and industrial sectors on their

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emissions and, therefore, the importance of understanding and designing carbon pricing policies
that take the characteristics of these sectors and national contexts into account.
In the Japanese context, whether for the industrial, energy, or other sectors, carbon pricing must
therefore also be coupled with broader companion policies that support research anddevelopment, bridge the gaps between innovation and deployment, and encourage investment
in less carbon-intensive alternatives. As climate ambition around the world ramps up andquestions of carbon leakage and competitiveness continue to arise, talks on CBAM are also
progressing. As part of the EU, Germany is squarely in the debate. CBAM is quickly gaining
momentum on Japan’s agenda too.
These in particular are areas where Germany and Japan can greatly benefit from sharedexperience. By fostering a continued and symbiotic dialogue on carbon pricing and broader
climate policy, Germany and Japan are presented the opportunity to increase their ambition anddemonstrate that international cooperation on climate action is greater than the sum of its parts.

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Appendix

Figure: Carbon price and emissions coverage of implemented carbon pricing initiatives
Source: World Bank

Appendix 1: The EU ETS at a glance

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Appendix 2: The EU ETS at a glance
The EU ETS at a Glance
Jurisdictions:

Member states: 28 EU Member States and three European Economic AreaEuropean Free Trade Association (EEA-EFTA) states: Iceland, Liechtenstein,
and Norway

Overall GHG
emissions (excluding
LULUCF)4391.9 MtCO2e in 2018 (3893.1 MtCO2e excluding the UK)

Overall GHG
emissions by sector

Energy 2907.1 MtCO2e ; Industrial processes 343.5 MtCO2e ; Agriculture394.4 MtCO2e; Waste 117.2 MtCO2e

GHG covered

CO2, N2O, PFCs

Sectors covered andthresholds

Phase I: Power generation and other combustion plants and industrial
facilities (oil refineries, coke ovens, iron and steel plants and facilities
producing cement, glass, lime, blocks, ceramics, pulp, paper, andcardboard).
Phase II: Sectors covered during Phase I, plus intra-European flights (since2012).
Phase III: Carbon capture and storage installations, production of
petrochemicals, ammonia, nonferrous and ferrous metals, gypsum,aluminum, as well as nitric, adipic, and glyoxylic acid (various thresholds)
were included.
Phase IV: Based on the current legislation, no changes to the scope havebeen agreed on for Phase 4. Changes are being considered as part of thereview of the ETS foreseen under the 2030 Climate Target Plan (please see"Year in review").

Cap

Phase I and II: The cap was established bottom-up, based on theaggregation of each member state's national allocation plans. Phase 1
started with a cap of 2,096 MtCO2e in 2005, Phase 2with a cap of 2,049
MtCO2e in 2009.
Phase III: A single EU-wide cap for stationary sources: 2,084 MtCO2e in
2013, which is annually reduced by a linear reduction factor (currently
1.74% or ~38.3 million allowances). This amounts to a cap of 1,816 MtCO2e
in 2020.
Phase IV: A single EU-wide cap for stationary installations set for 2021 at
1,572 MtCO2e. A linear cap reduction factor of 2.2% applies to both
stationary and aviation sectors each year. This translates into a year-onyear reduction of the cap by 43 million allowances. The linear reduction
factor does not have a sunset clause, and the cap will continue to decline
beyond 2030. Starting 2021, emissions from UK entities previously coveredby the EU ETS are no longer considered in the cap. However, under Article
9 and Annex 4 of the Protocol on Ireland/Northern Ireland, the cap
trajectory in Phase 4 accounts for emissions from electricity generators inNorthern Ireland.

Trading period

Phase I: 3 years (2005-2007)
Phase II:5 years (2008-2012)
Phase III: 8 years (2013-2020)

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Factsheet „Experiences with Carbon Pricing in Germany, the EU and Japan”
Phase IV:10 years (2021-2030)
Allocation

Phase I: Free distribution mostly based on historical criteria('grandfathering').
Phase II: Similar to Phase I, with some benchmarking on free allocationand certain auctions and sales (e.g., Germany).
Phase III: Auctions as primary allocation method (especially for the power
generation sector) and free allocation to industry based on benchmarking
and gradual increase in auctions' use.
Special rules for sectors confronted with the risk of carbon leakage (atemporary exception to the general policy of increasing auctions)Phase IV: Benchmark values are updated twice to reflect technologicalprogress in different sectors. The first set of benchmark values applies tothe period 2021-2025; the second set of values will cover the period from2026 to 2030. Member States submitted lists of incumbent installations
and updated emissions data by 30 September 2019 and must do so again
by 30 September 2024. Based on this data, the European Commission will
update Phase 3 benchmarks.

MRV

Each facility needs a monitoring plan approved by the competentauthority.
Annual report
Verification by an accredited independent verifier

Banking

Unlimited (since 2008)

Borrowing

Borrowing is not allowed. However, implicit borrowing within trading
periods is allowed —i.e., the use of allowances allocated in the current
year for compliance of the previous year.

Offset credits

Phase I: Unlimited use of CDM credits (in practice, there is neither demandnor supply).
Phase II: Almost all categories of CDM/JI credits are allowed, varying by
country to some extent. LULUCF credits and nuclear plants are notallowed, additional requirements for large hydropower projects.
Phase III: Similar to Phase II, but with additional quantitative andqualitative restrictions - new CDM credit only for LDCS projects, no credits
for new JI projects, no credits for specific industrial gas destruction
projects (e.g., HFC23). The total amount of international credits is limitedby the principle of "supplementarity" (no more than 50% emission
reductions).
Phase IV: Based on the current legislation, the use of offsets is notenvisaged.

Allowances
auctioning(Use of earnings)$80,737 million since 20092020: 21,769.6
2019: 16,413.5
2018: 16,747.3
Used for: Energy efficiency; Clean/renewable energy; Low-carbon
innovation; Research and demonstration of carbon capture and storage
technologies; GHG reduction programs.

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