Fostering Investment towards Reducing GHG Emissions

The first phase of the Korean ETS started with a humble object—that is, to establish the scheme as a new institution. Yet it did make statistically significant differences to GHG emissions generated by certain industries. That the effect was not observed across all industries cannot be counted as a fault of the ETS. As the goal of the ETS is to lower nationwide emission levels, insofar as the total emissions allowance is not exceeded and all targeted businesses trade and submit the emission permits they need, there is no reason for all industries to strive to reduce their emissions. Of course, the total emissions allowance of the Korean ETS will continue to decrease until the country achieves its target reduction level by 2030, and pressure will keep building for businesses participating in emissions trading to reduce their emissions. In the future, all industries may have to reduce their emissions to stay within the total allowance.

Reducing GHG emissions entails direct and opportunity costs. Considering the downsizing effect efforts to lower emissions could have on production and economic effects on the regional economy as well as the chain of related industries, it will be crucial for government and businesses to make increasing investment in effective technologies towards reducing emissions.

Policy support for reducing GHG emissions should thus encompass three approaches. First, it should be directed to foster the R&D on solutions that businesses can actually adopt toward reducing emissions, such as emission-controlling facilities, high-efficiency energy facilities, and manufacturing processes minimizing emissions. Second, policy should also provide sufficient incentives for continued investment in reducing emissions. All investors make their decisions by comparing the anticipated costs and benefits of their investment. Government can help reduce the cost of investment and maximize the benefits (Figure 5-1).

Figure 5- 1. Policy Support for Reducing GHG Emissions

온실가스 감 감 Reducing emissions

감 감 감 감 감 감 감 감 Investment in reducing emissions

감 감 감 감 감 감 Cost of investment

감 감 감 감 감 감 Benefit of investment

감 감 감 감 감 감 감 감 Support for R&D

감 감 감 감 감 감 감 감 감 감 Incentives for investment

감 감 감 감 감 감 감 감 감 감 감 감 감 Subsidies for emission-lowering solutions

2.1.1. Support for R&D

Before supporting R&D on solutions for reducing GHG emissions, the Korean government should first decide short- and mid-to-long-term goals to be met, and allocate policy support accordingly. In the short run, support should be directed to immediately applicable solutions that meet the identified needs of businesses. A major problem ETS-subject businesses face today is that, although the ETS and the gradual decrease in emissions allowances impose growing burdens on their operations, they do not have many emission-reducing options to choose from. The Korean ETS, in particular, targets indirect emissions from the use of electricity and heat energy as well. The best way to reduce indirect emissions is to adopt high-efficiency energy facilities. The use of electricity and heat, however, is directly related to the cost of production. Most businesses are therefore eager to adopt energy systems with the highest- possible level of efficiency. This means that, in order to help businesses already with such high- efficiency systems lower their emissions further, better energy systems that can readily be applied to actual production must be developed.

The Korean government should ascertain the R&D needs of ETS-subject businesses and prioritize the development of solutions that can be applied in the short run. This will help reduce GHG emissions substantially, and alleviate the significant burdens businesses face in terms of R&D, lowering emissions, and purchasing emission permits.

In the intermediate to long run, government support should be directed to developing original technologies. The steel, petrochemical, semiconductor and display industries are pillars of the Korean economy that involve massive facilities with massive processes of extreme complexity. Korean manufacturers, however, rely mostly on imported machinery, processes and devices. This limits the extent to which they can modify their existing facilities and processes to reduce emissions. Such modifications may cause problems with the existing facilities and processes that suppliers may not be willing to service. It is therefore critical to support the development of emission-lowering facilities,

processes and other such technologies to enable Korean businesses to adopt such solutions actively in the future.

2.1.2. Support for Investment

The Act on the Allocation and Trading of Greenhouse Gas Emission Permits and the Enforcement Decree thereof require the government to provide fiscal and tax support for investment in reducing emissions. Various ministries and agencies have introduced investment support programs for their respective industries/sectors accordingly. The Ministry of Trade, Industry and Energy (MOTIE), for example, provides the GHG Emission-Reducing Facility Support Program for ETS-Participating Businesses for small and medium-sized enterprises (SMEs) in the transition and power generation sectors. The Ministry of Environment (ME) provides a similar program for waste-handling businesses.

The level of support under these individual programs is nothing impressive, though. The MOTIE’s program, for example, had an annual budget of KRW 2.234 billion in 2018 and 2019 each, which pales in comparison to the share of the transition and manufacturing sectors in the ETS.

Beginning in 2019, the Korean government began to allocate paid-for emission permits via bidding for part of emission allowances. This was already announced in the ETS Master Plan (MOSF, 2014).

However, policymakers have not yet determined how to use the proceeds from the bids. Using them to expand the investment support programs of individual ministries will enable more businesses to benefit from these programs. Some programs place a ceiling on the amount of fiscal support each business may receive. Such limits, however, should be lifted or at least raised so as not to curb investment in costly, but effective, emissions projects.

2.1.3. Stronger Incentives for Investment

The Korean ETS currently bases emission permits on past emission records. However, this means that heavy-emitter businesses are allocated more free emission permits than non-heavy emitters, consequently facing relatively little pressure to reduce their emissions. The current incentive structure should therefore be reformed so as to benefit businesses that have been proactively reducing their emissions by investing actively in new solutions. The part of emission allowances based on benchmarks should be increased, with one caveat. Setting benchmarks by industry could end up distorting the market because some heavy-emitting industries contain relatively few businesses. The mining, oil refinery, lumber, ceramics, display and shipbuilding industries, for example, consist of 10 or fewer businesses each, necessitating careful deliberation in determining benchmarks therein. One alternative to product- by-product benchmarks may be heat- or energy-based benchmarks used in the EU-ETS.

Ensuring equity between industries is another important matter of consideration. In setting benchmarks, businesses in some industries may benefit more than others, while those in other industries with relatively high benchmarks may face undue increases in pressure to reduce their emissions. This is an outcome that should be avoided.

With the goal of increasing benefits for businesses investing in emissions-reducing solutions and fostering such investment, the Korean government introduced new incentives starting with the second phase of the ETS. Under the Guidelines on Allocating, Adjusting and Revoking GHG Emission Permits,

the certified amounts by which businesses managed to reduce their emissions in the preceding phase are to be added to projected emissions that underline emission allowances for subsequent phases so that businesses that reduced emissions can receive a greater number of allowances.

However, only a few methods—CDM, external business, and KVER—can be used to verify and certify reduction in GHG emissions by businesses. The excessive rigor of the manner in which these methods are applied has meant that the number of businesses that actually succeeded in having their emission-lowering efforts certified has remained relatively small. The new incentive therefore invites questions over its projected utility, notwithstanding its intent. The Korean government should engage businesses in communication and find more applicable methods for certifying the amounts of GHG emissions they actually decrease.

Furthermore, certified reductions in emissions can be carried forward only into the immediately succeeding phase, and not into the phases further down. More long-term benefits should be provided for businesses in light of the lifespans of the new solutions they adopt, the size of investments they make, and the duration of the effects of their investments.

The majority of ETS-subject businesses in Korea have already adopted highly efficient energy facilities. Many do so upon acquiring new facilities in the first place. However, the current system of emissions allocation enforces certain coefficients of adjustment, requiring businesses across the board to reduce their emissions by certain percentages. This actually leads businesses to operate their high- efficiency energy facilities less than their capacities warrant or otherwise purchase additional emission permits. This, in turn, reduces their need to adopt more energy-efficient facilities and solutions, causing them to postpone investment in emissions-reducing technologies. It is therefore important for the government to revisit its policy so that businesses acquiring new facilities can be exempt from the set coefficients of adjustment when the efficiency of their new facilities meet certain emissions-related criteria.