ANALYSIS: Korea ETS poised for revamp after torturous first year

Published 13:26 on January 14, 2016  /  Last updated at 13:26 on January 14, 2016  /  Asia Pacific, International, Kyoto Mechanisms, South Korea  /  No Comments

Emitters in South Korea's ETS, the world’s second-biggest carbon market, expect changes to policy settings and a slight rise in trading activity after an inaugural year that landed dozens of lawsuits on the government’s desk and only saw minuscule volumes change hands.

Emitters in South Korea’s ETS, the world’s second-biggest carbon market, expect changes to policy settings and a slight rise in trading activity after an inaugural year that landed dozens of lawsuits on the government’s desk and only saw minuscule volumes change hands.

Launched a year ago, the Korean ETS caps more than 570 million tonnes of CO2e and is intended to help meet the government’s target of limiting 2020 greenhouse gas emissions to 30% below BAU levels.

The scheme was the centrepiece of former President Lee Myung-bak’s green growth agenda, which was introduced to close the clean technology gap between South Korea and western nations.

But rather than embracing Lee’s vision, Korean industry has rebelled and filed more than 40 legal cases against the Ministry of Environment over the way it has implemented the scheme. Most of the suits seek a greater number of allowances.

A Seoul court last month dismissed the first of the lawsuits but there are many more in the pipeline, and observers fear they may hinder the development of the nascent market for several years as many cases are escalated to the Supreme Court.

In response to charges that the environment ministry botched the market’s design and launch, the responsibility for the ETS is now about to be shifted by the Korean government to the Ministry of Strategy and Finance.

“There is widespread expectation within the Korean industry that the government will likely give in to the industry’s request to adjust the allocations. The recent decision by the government [to take responsibility away from the environment ministry], although not publicly announced yet, is one of the policy signals which made industry believe that there will be significant changes in the ETS rules and allocations,” Joo-jin Kim, a lawyer with consultancy ELPS, told Carbon Pulse.

CHANGES

At the heart of industry’s complaints is the Ministry of Environment’s estimate of 2020 BAU emissions, which business lobby groups and a number of economists say was too low and resulted in allowance allocation levels at 10-20% below what industry said they required.  This, ETS participants allege, has made company emission reduction targets impossible to meet.

Korean Allowance Units (KAUs) first traded a year ago at 8,640 won and are currently valued on the secondary market at 12,000 won ($9.87/€9.04).

At these prices, the carbon market could represent a considerable financial burden on the scheme’s 200 or so participating companies in the form of compliance and non-compliance penalty costs, which could collectively run into billions of dollars if the industry’s predictions of a sizeable overall deficit are correct.

Only days after last month’s Paris Agreement, the South Korean government reiterated a plan to build a further 20 coal-fired power plants by 2021, and observers suspect that shifting ETS responsibility to the Ministry of Strategy and Planning increases the chances that CO2 allowance allocation levels will rise because it will have a more sympathetic stance towards emitters than the environment ministry.

Observers also say that ETS’ new management makes it more likely that some government KAU reserves, which amount to around 30 million per year over 2015-2017, might be released into the market to feed demand and lower prices.

They added that there is also a slight chance that South Korea may allow its industry to use international carbon offsets, most likely CERs.

In response to a newspaper article in March last year, the Ministry of Environment said in a statement that, based on its assessment of prices and compliance rates in the domestic market, it could consider allowing ETS participants to foreign use offsets to cover a maximum of 5% of their emissions.

According to experts, the environment ministry was unlikely to go ahead with that rule change, but the strategy and planning ministry’s position on the issue is less clear.

SLOW MARKET

Market activity has suffered amid the controversy surrounding the Korean ETS.

In the first 12 months of the scheme, 321,000 KAUs have traded on the Korea Exchange (KRX) – the only bourse allowed to host trading – in a market that saw around 545 million allowances handed out for free to emitters for 2015.

Offset trade has been only slightly more liquid, with 920,000 Korean Carbon Units (KCUs) changing hands on the exchange.

Project owners have sold between 5-7 million of a second offset type – Korean Offset Credits (KOCs) – on the OTC market.

“The low liquidity in KAUs is due to companies finding it difficult to secure supply. Companies that are potential suppliers are cautious to sell KAUs in a rising market and due to uncertainty related to future KAU needs in case of increased production,” Thomas Winklehner, CEO of traders Korea Carbon, told Carbon Pulse.

A lack of experience in environmental commodity trading is also impacting the market, according to ELPS’ Kim.

“Industry and regulators in general lack experience using market-based mechanisms in resolving environmental matters. Korea also lacks experience with energy commodities, as the Korean energy market has been quite tightly controlled by the government until now,” he said.

“Rather than taking the unbeaten track of selling and trading their KAUs, Korean industries have tried to be on the safe side – doing nothing.”

Winklehner agreed, adding: “I think that liquidity will increase slightly as more companies get familiar with the market and the potential release of some [KAU] reserves by the government”.

CLARIFICATIONS

While the government’s allocation plan stipulates that some 41.4 million KAUs were to be distributed to companies that can document early action, Young-hun Choi, an analyst with ICIS-Tschach said that a lack of information about how much each firm would receive has kept potential sellers out of the market.

The government also plans to compensate local upstream utilities for their emissions costs using a reference price that it has not yet finalised.

“Greater trading volume is expected once the reference price for the power sector emissions costs compensation scheme is set within H1 2016, and after the early action reserve is distributed,” he said.

OFFSETS

Meanwhile, the complicated Korean offset market has suffered from the fact that only compliance buyers are allowed to purchase KCUs, according to Korea Carbon’s Winklehner.

Domestic offset project developers receive KOCs, including those firms that have received CERs from the UN but want to voluntarily cancel them in order to convert the emissions reductions into domestic offsets. KOCs must then be converted to KCUs before they can be used for ETS compliance.

KOCs also are not tradable on the KRX, which has led to the development of an opaque OTC market for the offsets.

The KRX said last month it will launch KOC trading in May, but that will come too late to handle the sales of most of the converted CERs currently held by tradinghouses, Winklehner said.

“Fresh supply of KOCs is likely to be for compliance companies, which might be needed for internal compliance rather than for sale to other companies. KCU trading might not pick up as most of the volume issued in 2015 has already been sold,” he said.

By Stian Reklev – stian@carbon-pulse.com

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