As the host country of the Kyoto Protocol, Japan celebrated the treaty's entry into force with considerable fanfare. In the early months of trading, however, Japanese businesses have been noticeably absent in the world of carbon finance. The Ecosystem Marketplace asks why Japan's private sector has been slow to invest and considers whether the early efforts of the country's first carbon fund might soon shake things up a bit. On the evening of February 16th, 2005 the Diet building in the heart of Tokyo was packed with politicians and environmentalists celebrating the Kyoto Protocol's entry into force. As the microphone moved from hand to hand — 30 or 40 in all — each speaker appeared more anxious than the last to declare a commitment to reducing green house gases (GHGs). At the end of the night, a mammoth red globe constructed of papier-mâché circulated the room. Members of the audience were asked to paste blue and green slips of paper to its surface in order to help "cool the earth down". On a less symbolic level, Japan has pledged, under the Kyoto Protocol, to curb its greenhouse gas emissions by 6 percent from the 1990 level by 2012. Emissions in fiscal year 2002, however, were 7.6 percent higher than the 1990 level. In fiscal year 2003, they were 8 percent higher. To the admittedly cynical observer who sat pasting blue paper over red in the Diet building on February 16th, the Kyoto Protocol's host country seemed in dire need of less talk and more action in the climate change department. Fortunately, the country may be getting just such a dose of action in the form of Asia's first big carbon fund.
A New Player in Asia
Launched in late 2004, the financial group Japan Carbon Finance Ltd. (JCF) has received committed funds of approximately US$140 million for its Japan GHG Reduction Fund (JGRF). JCF says it will use the fund to purchase emission reductions credits from Clean Development Mechanism (CDM) and Joint Implementation (JI) projects in developing and "in-transition" economies around the world. Designed to reduce both the risks and the costs associated with purchasing emissions credits from projects in developing countries, tools like JGRF have emerged throughout Europe, but, until now, have not been much seen in Asia. JCF's new venture thus represents the welcome entry of some of the biggest carbon players in Japan into the global carbon finance game. Contributors to JGRF include lending institutions like the Development Bank of Japan (DBJ) and the Japan Bank for International Cooperation (JBIC), as well as manufacturers like Toyota Motor Corporation and Sony Corporation, several oil and gas producers, and last but not least, the entire body of Japanese electric utilities. Shinji Ayuha of DBJ likens JCF to a similar program launched recently by the KfW Bankengruppe of Germany. Specifically, Ayuha predicts that, like KfW in Europe, JCF will have an important role to play in Asia as an intermediary in the region's fledgling carbon market. Soon after JCF was launched last year, JBIC began signing cooperation agreements with Viet Nam, Romania, Colombia, and corporations within the Latin America and Caribbean Region. Under these agreements, the Designated National Authorities (DNAs) in these respective countries agreed to supply JBIC with information about prospective JI and CDM projects in their countries. The bank will then pass this information on to JCF, which will act as the principal potential buyer of emissions reduction credits. Last month, JCF also announced a more direct Memorandum of Association with The Energy and Resources Institute (TERI), based in India. Together, the two institutions say they plan to develop CDM projects throughout South Asia for selection under JGRF. "We understand and appreciate India's leading position in CDM and we are happy to be associated with TERI for its significant contribution to facilitate CDM so far," says Hiromu Tanaka, President, Japan Carbon Finance Ltd. According to the agreement, TERI will solicit and screen project proposals from organizations that are looking to develop CDM projects in South Asian countries, including India. It will then forward these proposals to the JCF, which will finalize the selection of those projects in which it will then invest. "This Facility will assist local developers to reduce some of the up-front costs of CDM project development," says Dr. R.K. Pachauri, Director-General of TERI. "The CDM projects developed under this initiative will contribute significantly in meeting the Kyoto targets by Japan and I believe that it will assist in achieving South Asia's sustainable development goals and underscore its contribution towards mitigating climate change."
Playing to its Strengths
JCF managers say that, in prescreening around 50 projects for JGRF's initial portfolio, they are using the experience and knowledge of the fund's backers to carve out a competitive niche for themselves. As with most funds, JCF says that it is screening projects for its initial portfolio based on several factors, including their fulfillment of Kyoto rules and their contribution to the environmental, social and sustainable development aims of the host country. Additionally, JCF has set portfolio limits on the amount of emissions credits to be purchased from any single project, any single host country, and any single sector of industry — renewable energy, waste handling, manufacturing, agriculture, etc. — thus ensuring that its investments will be representative and diverse. Joichi Kimura, the deputy director general of the Carbon Finance department at JCF, and a deal manager responsible for the pre-screening process, says that "the know-how to purchase emissions credits isn't something that all fund providers necessarily possess. JCF does have this know-how." Specifically, architects of the JGRF pool stress that the two biggest public lending institutions behind it — the Japan Bank for International Cooperation and the Development Bank of Japan — together possess unparalleled knowledge of the international and domestic markets. "The banks were chosen for their relative strengths," one official told the International Environment Reporter. "JBIC — the world's largest foreign aid lender, topping even the World Bank — is adept at foreign projects, while the Development Bank of Japan has more domestic experience." In addition, JGRF's managers say they plan to play to their stakeholders' strengths by investing in projects like biomass power generation, co-generation plant construction, and increased operating efficiency at existing thermal power plants — all areas in which Japanese power companies have advanced knowledge and technology. "JCF makes use of the knowledge possessed by the 33 firms contributing to the JGRF to the greatest extent possible," says Shuji Isone, another deal manager at JCF.
A Sleepy Market
While the entrance of JGRF into the carbon market is a welcome sign of progress, many market analysts warn that Japan still has a ways to go before it catches up with its Kyoto commitments. "European companies are offering six dollars per one ton of carbon dioxide emissions, but Japanese seem to be unhurried with their offer of five dollars per ton," an Indian government delegate recently observed at a Tokyo conference on CDM projects. In fiscal 2003, Japan's emissions increased 8 percent from their 1990 level to 1.336 billion tons. In achieving its target of a 6-percent reduction of GHG emissions from the level in 1990, it is important for Japan to make use of the Kyoto mechanisms like JI and CDM. But recent reports suggest that Japan will need to contract credits for some 100 million tons of CO2 emissions if it is to meet its Kyoto targets by 2012. According to the Jiji Press wire, Japanese companies have only invested in 15 CDM deals so far, covering a mere 8.24 million tons of carbon dioxide in all. Why are Japanese businesses so reticent to get in the game? Takamitsu Sawa, an Economics Professor at Kyoto University, argues that the United States withdrawal from Kyoto has left many Japanese corporations reluctant to invest in CDM projects because the value of resulting emissions credits is far from guaranteed. "The Japanese government should encourage Japanese companies to undertake CDM projects by promising to buy at a fair price the carbon credits they earn through development," says Sawa. "Prices should be set according to the domestic marginal cost of emissions reduction, prices in the European Union's carbon market and other relevant factors, and in ways that give domestic companies CDM incentives." "Without such measures," he warns, "once the first commitment period under the protocol is over, Japan will have to purchase Russia's "hot air" through one-on-one transactions to acquire emission rights."
Escaping Kyoto's Constraints
Another common concern about the Kyoto Protocol among Japanese businessmen is that its initiatives fail to cast a closed net. 141 countries have signed the Kyoto Protocol, but, at present, it only covers one-third of the world's total greenhouse gas emissions. There are numerous countries aside from the United States that have not ratified the protocol, or are not yet obligated to reduce emissions under it. These countries may be attractive to companies whose energy costs are significant and thus whose competitiveness is threatened by adherence to Kyoto's demands. Japan has many such industries. A research report produced by DBJ notes that "for industries like iron and steel that have high percentage energy costs and use forms of energy with high carbon content, the latent risks of being located in Japan could become very real as the government strengthens policies to fight global warming." Industries producing ceramic, stone, and clay products also have high percentage energy costs, and since the oil shock of 1979-80 have been relying on coal for nearly half of their energy consumption; these industries, too, are put at risk by government-enforced initiatives aimed at reducing GHG emissions. For these industries, China's burgeoning economy may become ever more alluring. Market-based controls of GHG, such as the trading of carbon emissions facilitated by groups like JCF thus are not a complete solution in Japan. At some point, Kimura admits, the costs associated with offsetting emissions through Kyoto certified projects may exceed the costs of simply packing up operations and moving them outside the perimeter affected by the treaty. Indeed, such a shift in balance may well come soon. Witness the fact that Seizo Matsumoto, Vice Minister for Global Environment Affairs at Japan's Environment Ministry, recently hinted that an environmental tax might be on the way in order to help Japan meet its 6% GHG reduction commitment. "Introduction of the environmental tax would contribute to reducing greenhouse gas emissions in three ways," he explained, "namely, price, financial resources, and announcement effects." Given the increasing pressures on companies in Japan, China and the other developing economies of East and South-East Asia that are currently not required to make GHG reductions under Kyoto protocol may make attractive destinations for Japan's most heavily burdened companies. While Matsumoto and the Environment Ministry have high hopes for increased official cooperation with China — there is currently talk of exchanging sustainable wind power, solar power, and biomass technologies — the effect of Japanese companies fleeing their country's strict regulatory regimes may, in fact, offset any real benefit of such cooperation. For this reason, JCF's Kimura argues that "controls which restrict companies from moving abroad in order to meet their targets may also be necessary". Otherwise, he warns that, when it comes to the Kyoto Protocol, some businesses may prefer to jump ship to China before they ever really get on board in Japan. Andrew Bell is a researcher in environmental engineering at Waseda University in Tokyo. He can be reached via email at firstname.lastname@example.org.