South Korea’s emissions trading scheme

This White Paper has been produced by Bloomberg New Energy Finance in cooperation with Ernst & Young Korea. Please click here to download the PDF.

EXECUTIVE SUMMARY

South Korea will launch its emissions trading scheme in a little over 18 months. The government has yet to finalise the design of the scheme and is currently engaged in an active dialogue with industry. This White Paper aims to contribute to the debate by assessing how the various design options will affect the price of carbon and the efficiency of the market.

● Our analysis indicates that the country’s overall emissions reduction target of 30% below business-as-usual (BAU) levels by 2020 is ambitious.

● The price of carbon in South Korea is likely to be high compared with other schemes, if the ETS is implemented in line with the government’s original design proposal. This is because the level of low-cost abatement available in the power and industry sectors is unlikely to be sufficient to meet the 2020 target, even with the option of using offsets up to the proposed limit of 10% of compliance obligation.

● We anticipate that the emission-trading scheme (ETS) will cover around 70% of South Korea’s greenhouse-gas output, creating demand for abatement of over 200Mt in 2020 – almost double that forecast for the Australian and EU emission-trading schemes.

● Without a carbon price, we estimate that emissions in the sectors covered by the ETS will grow by 28% between 2010 and 2020. Industrial greenhouse-gas output will rise by almost 40% over that period on the back of the semiconductor and display technology sectors, while power sector growth (20%) will be tempered by renewable and nuclear capacity additions.

● Until 2020, the programme would require 822Mt of cumulative emissions reductions relative to BAU. The current design proposal will limit offset usage to an estimated 238Mt – 29% of abatement demand to 2020. This must be supplied only by domestic offsets if international credits are not allowed until 2021.

● The current pipeline of domestic offset projects is likely to be insufficient – 21Mt of Certified Emission reductions (CER) and 6Mt of Korea Verified Emission Reduction (KVER) credits per year – meaning that additional domestic offset projects will need to be created to meet demand. A domestic forestry offsets scheme is being created and could play a major role in the provision of eligible credits for the ETS.

● Assuming participants submit offsets up to the maximum limit of 10% of emissions, the remaining demand for abatement in for example 2020 will be 169Mt/yr. We have identified only 119Mt/yr of abatement potential in the power and industry sectors, meaning that covered entities will need to achieve 50Mt/yr of additional emission reductions below BAU by 2020.

● The exact cost of abatement in the ETS is unclear, but with this high demand, the carbon price could rise to the long-run cost of new natural gas and renewable capacity, or the implementation of carbon capture and storage (CCS) technology – all above KRW 150,000/tCO2e ($130/tCO2e).

● If this price level is deemed too high, the government may consider changing the original design plan with one of the following options: ease the emission reduction target, allow more offset credits before 2020, or implement price containment measures such as a price cap.

● The design plans suggest a penalty surcharge of three times the average market price during the compliance year, up to a maximum of KRW 100,000/tCO2e (some $90/t) if covered entities fail to comply. If participants do not need to submit allowances in addition to paying the penalty charge, this will effectively act as a price ceiling for the scheme.

● As to the other design elements, in our opinion the scheme should cover direct emissions only. Including indirect emissions would incentivise covered sectors to improve their energy efficiency for power consumption. But it could lead to misallocation, while complicating the allocation and reporting process.

● Also, restrictions placed on third-party participation in the ETS will likely be counterproductive for the market as third-party actors are needed to develop trading channels and provide liquidity in order for the market to function smoothly.

● The regulated structure of South Korea’s power market will probably impede the efficiency and effectiveness of the ETS. Liberalisation of the power sector is necessary to allow utilities to pass through the cost of carbon to consumers, and gain maximum benefit from the scheme.