Japan’s Carbon Market Innovation: Pioneering the Inclusion of Carbon Removal Credits  

The Japanese government announced in April 2024 that it will allow carbon dioxide removal (CDR) credits from four project types, including overseas developments, in its GX League emissions trading scheme (GX-ETS). Specifically, from April 22, 2024, the GX-ETS will start accepting project registration applications for “other eligible carbon credits” for up to 5% of greenhouse gas emissions in several new sectors. The eligible CDR project types are:

  • Carbon capture, utilisation and storage (CCUS)

  • Coastal blue carbon

  • Bioenergy with carbon capture and storage including BiCRS (BECCS)

  • Direct air capture and carbon storage (DACCS)

Other unnamed project types may be considered for future inclusion. This decision makes Japan the first country to incorporate durable carbon dioxide removal credits into its national emissions trading system compliance framework.

The GX-ETS will initially operate as a voluntary baseline-and-credit system from fiscal year 2023 until 2026, before transitioning to a mandatory cap-and-trade system. During the voluntary phase, companies will be required to pledge emission reduction targets and disclose them on a “GX Dashboard”. If targets are not met, companies must explain why via a “Comply or Explain” mechanism.

Given Japan’s annual emissions of around 1.1 billion tonnes of CO2, this equates to a potential demand of 30 million CDR credits per year – a significant market signal for the nascent CDR industry.

To be eligible, CDR projects must demonstrate additionality, permanence (typically over 100 years), and robust monitoring, reporting and verification (MRV). Companies wishing to use CDR credits in the GX-ETS must also have a total investment of at least 20% in a project or provide technologies or solutions to the project.

While the inclusion of CDR credits in the GX-ETS is a pioneering move, it also presents some challenges. The current high costs of technology-based CDR solutions like DACCS, ranging from $450-$1000 per tonne of CO2 removed, could limit their immediate uptake in the market. There are also concerns about the challenges of MRV for international credits and ensuring a sufficient supply of high-quality domestic credits.

As the GX-ETS evolves and matures, it will be crucial to balance these factors and ensure robust participation, a liquid market, and high-quality credits. The government will need to engage stakeholders and carefully design policies to address competitiveness concerns while still driving meaningful emissions reductions in line with Japan’s net-zero goal.

Despite the challenges, Japan’s GX-ETS represents a significant step forward in the use of market mechanisms to drive decarbonisation. By pioneering the inclusion of CDR credits, Japan is sending a strong signal to the global carbon market and could help spur investment and innovation in the CDR industry. As other countries watch and learn from Japan’s experience, the GX-ETS could provide valuable lessons for the design of future carbon markets that incorporate carbon removal solutions.