Written By Schumi Chen
When distilled in definition, carbon credits are simply permits granted for emitting specific amounts of greenhouse gasses – and represent the foundation of our modern efforts to mitigate and control the effects of climate change (World Bank, 2022). Carbon credits serve as the basis of carbon markets, which incentivize emission reductions by assigning a monetary value to the carbon output of individual stakeholders within a specific industry or nation. A good example of such a system would be the European Union Emissions trading System (EU ETS), which highlights the potential of the carbon credit market, giving us a glimpse of what a transformative future can be–– achieving a 47% reduction in emissions from covered sectors since 2005 (European Commission, 2023).
With the continued rise and development of Asian countries, a significant portion of global carbon emissions now stem from the region, prompting a strong push towards exploring carbon trading as a means to kickstart its decarbonization efforts. This expository report seeks to cross examine the structure and successes of the EU ETS with the current Asian market in order to evaluate the potential for a formalized system in the region. Drawing from Europe’s two decades of experience in carbon regulation will highlight both the opportunities and challenges of leveraging carbon markets for Asia’s sustainable future.
The European Union Emissions trading System (EU ETS)
Having been established in 2005, the EU ETS serves as not just the world’s first, but also largest international carbon trading market/platform. The EU ETS operates on a cap-and-trade principle, where a hard limit on greenhouse gas emissions is set in place for key sectors to abide by within the European Economic Area–– which include the power generation industry, heavy industry, and aerospace industry (European Commission, 2023). Companies operating within such industries are also allocated emission allowances, which they can trade on the open market depending on their needs, incentivizing energy efficiencies and reductions across the board.
So, what exactly has made the EU ETS so successful? As the world’s first economic region to introduce such a system, the EU ETS had to start from the ground up. Utilizing a phased implementation, the system began with a pilot phase between 2005 and 2007, gradually introducing stricter caps and covering additional sectors in subsequent phases (Ellerman, 2010). As the EU notably consists of multiple participating nations (27 nations), market stability has always been a topic of concern. In order to tackle this, measures such as the Market Stability Reserve (MSR) were introduced in 2019, safeguarding prices from unwarranted fluctuation by adjusting the supply of allowances based on market conditions (European Commission, 2023).
Throughout the past two decades, the EU ETS has achieved considerable success, immediately noticeable through the 47% reduction in emissions since 2005, while raising a staggering $27.1 billion in 2023 alone; creating a snowballing effect where additional funds are now available to be used in investments within the renewable energy sector (Reuters, 2023). Despite the seemingly successful initiative, challenges remain. Price volatility (although later mitigated), insufficient caps in early phases, and the need for a complete policy alignment amongst participating nation states have tested the system’s efficacy (Laing, 2013). Despite this, time has proven that nations be willing, a carbon system similar to that of the EU ETS offers a valuable look into future energy and environmental developments in Asia, made possible by basing the EU ETS as a benchmark.
Current state of carbon markets in Asia
With the presence of multiple NICs, Asia is rapidly proving to be a key player in the global carbon market landscape. Several countries within Asia have spearheaded their own carbon trading initiatives tailored to their economic and environmental needs. As such, the current carbon market in Asia remains largely decentralized, with a mix between compliance-based and voluntary approaches, highlighting the diversity of strategies in the region.
A prime example of a compliance-based system would be the Chinese national carbon trading scheme. Launched in 2021 at the peak of its industrial prowess, Chinese national carbon trading scheme is now the largest carbon market by volume. Initially covering over 2200 power plants–– accounting for 40% of China’s total emissions, the system has plans to expand to other major nationally subsidized sectors such as Steel & Cement in the coming years (ICAP, 2023). Other notable examples of compliance-based systems are developed nations such as South Korea, who have long established their own unique ETS (Emissions Trading System) in 2015, covering an approximate 60% of the nation’s emissions, setting an ambitious reduction target in alignment with its 2050 net-zero goals, mirroring that of the EU itself. During this approximate timeframe, Singapore has also implemented a carbon tax. Although rudimentary in nature compared to the compliance based ETS systems of China and South Korea, Singapore requires high-emitting facilities to pay for their emissions and lays the groundwork for a potential carbon trading platform within the ASEAN economic union.
Voluntary carbon markets, on the other hand, are also gaining traction in Asia. Corporations are increasingly purchasing offsets to meet sustainability commitments, especially in newly developing markets such as Indonesia and India. However, to remain globally competitive, compliance based carbon markets still prevail amongst major and developed economies, driven by government mandates to align with global climate agreements.
Potential for a formal Carbon Credit System in Asia
How feasible is the implementation of an ETS in Asia? With the diverse economies, and abundant natural resources at hand, the growing commitment to climate action represents a significant opportunity to develop a formal and unified carbon credit system. Such a system could drive investment in renewable energy, natural climate solutions and energy efficiency on the road to transition to a low-carbon economy.
The Association of Southeast Asian Nations (ASEAN) highlights a unique opportunity to develop a major and unified ETS system that complements the EU ETS. There are already initiatives set in place for this, such as ASEAN’s Plan of Action for Energy Cooperation (APAEC), which emphasizes regional collaboration on renewable energy and energy efficiency, providing a strong foundation for an integrated carbon market (ASEAN Centre for Energy, 2020). Establishing an intra-regional trading framework opens up the ability for countries to leverage their comparative advantages, such as Indonesia’s reforestation capabilities and Vietnam’s growing solar capacity.
Natural climate solutions such as reforestation using mangroves are amongst the most promising prospects in Asia. Southeast Asia is home to nearly 35% of the world’s mangroves, which act as carbon sinks and generate high-value carbon credits (Asian Development Bank, 2021). Expanding these initiatives would not only help reduce emissions, but serve as a catalyst for further FDI into the developing region. Numbers are particularly optimistic, with estimates suggesting that Asia’s carbon market could reach a market value of over $100 billion by 2030, making it a vital player in the global carbon economy (Asian Development Bank, 2021). However, there remains a particular barrier to entry–– the lack of an aligned policy framework that allows for a robust monitoring and reporting system to be established. An aligned policy framework is critical to the maintenance of Asia’s market integrity.
What has the EU ETS taught us?
1) The importance of Long-Term Visibility and Targets
One of the main strengths of the EU ETS lies in its clearly defined, long-term emission reduction goals. These targets provide certainty for businesses and investors, helping legitimize the carbon market. For example, the EU has committed to reducing greenhouse gas emissions by at least 55% by 2030 compared to 1990 levels, aligning the ETS with
broader climate policies (European Commission, 2023). Asian countries can benefit from similarly ambitious targets, given that full participation cooperation is achieved. This would also be beneficial to emerging investment opportunities in low-carbon tech.
2) Gradual Implementation and Sector-Specific Approaches
The phased implementation of the EU ETS has allowed for adjustments in accordance to returns in the real world. An example would be the initial pilot phase that provided valuable feedback in what should be implemented in the following phases, e.g. the expansion of sectoral coverage and the tightening of carbon caps (Ellerman, 2010). By adopting a similar strategy, Asia will have a clear roadmap to help develop a successful and unified ETS system.
3) Market Stability Measures & Price Control mechanisms
As demonstrated in the early years of the EU ETS, price volatility presents itself as a very real problem–– one which was tackled by the introduction of the Market Stability Reserve (MSR). The MSR automatically adjusts the supply of allowances based on market conditions, guaranteeing the stability of carbon prices (Laing 2013).
4) Addressing Free Allowances and Predatory Behaviour
In order to initially gauge the carbon market, the EU ETS relied on the free allocation of carbon allowances to industries at risk of carbon leakages, away from the legacy auction-based allocation. This approach mitigates predatory market behavior whilst continuing to encourage emission reductions (Ellerman, 2010). This strategy is especially useful for Asia, as it will allow a healthy balance of economic growth whilst abiding to climate targets, as emergent economies are known to be heavily reliant on carbon-intensive industries.
Conclusion
The establishment of a formal carbon credit system in Asia underscores Asia’s immense potential to transition to a low-carbon economy through the addressing of both its environmental and economic challenges. The EU ETS embodies the ideal mechanism for reducing emission whilst fostering innovation and sustainable development, something Asia should be eager to follow in the footsteps of.
References
Asian Development Bank. (2021). Carbon markets in a changing climate: Opportunities for Asia and the Pacific. Retrieved from https://www.adb.org/publications/carbon-markets-changing-climate
Association of Southeast Asian Nations (ASEAN) Centre for Energy. (2020). ASEAN Plan of Action for Energy Cooperation (APAEC) 2016–2025. Retrieved from
https://aseanenergy.org/asean-plan-of-action-for-energy-cooperation-apaec-2016-2025
Ellerman, A. D., Convery, F. J., & de Perthuis, C. (2010). Pricing carbon: The European Union Emissions Trading Scheme. Cambridge University Press.
European Commission. (2023). EU Emissions Trading System (EU ETS). Retrieved from https://ec.europa.eu/clima/policies/ets_en
International Carbon Action Partnership (ICAP). (2023). Emissions trading worldwide: Status report 2023. Retrieved from https://icapcarbonaction.com/en/status-report-2023
Laing, T., Sato, M., Grubb, M., & Comberti, C. (2013). Assessing the effectiveness of the EU Emissions Trading System. Centre for Climate Change Economics and Policy Working Paper No. 126. Retrieved from https://www.lse.ac.uk/granthaminstitute/wp-content/uploads/2014/02/WP106-effectiveness-eu-e missions-trading-system.pdf
Reuters. (2023). Global 2023 carbon trading revenues grew to $74 billion, report says. Retrieved from https://www.reuters.com/markets/carbon/global-2023-carbon-trading-revenues-grew-74-bln-repo rt-says-2024-04-10
United Nations Framework Convention on Climate Change (UNFCCC). (2021). Challenges and opportunities for carbon markets in Asia. Retrieved from https://unfccc.int/sites/default/files/resource/Challenges_Opportunities_Carbon_Markets_Asia.p df
World Bank. (2022). State and trends of carbon pricing 2022. Retrieved from https://openknowledge.worldbank.org/handle/10986/37455