South Korean ETS - An Emerging Carbon Market

South Korea's ETS is now up and running and Redshaw Advisors are running a workshop on the way carbon marketsoperate and evolve for the Korean Power Generators Association (the Genco Cooperation Service). To help keep those interested in global carbon markets up to speed we thought it would be interesting to share some key facts about the South Korean ETS and its performance to date.

The South Korean ETS was launched on 1st January, 2015 with the aim of being the primary policy to cut South Korea's Business As Usual greenhouse gas emissions by 30% by 2020. The scheme will cover companies with annual emissions of 125,000 tonnes or more and single installations that emit more than 25,000 tonnes. This will mainly cover the power generators, large industry and building and transport sectors. In total there are 525 business entities in the scheme and that includes 5 domestic airlines. So it is not just the EU that are trying to drag the aviation sector into emissions trading. The Korean ETS is also ground breaking because it covers all 6 Kyoto Protocol greenhouse gases (CO2, CH4, N2O, PFCs, HFCs and SF6)

There are 3 phases set out so far, they are;

Primary planning period: 2015-17

Secondary planning period: 2018-2020

Third planning period: 2021-2025

The cap for the primary planning period has been set at 1.69 billion tonnes of allowances (573Mt, 562, 551Mt allocated in each of 2015, 2016 and 2017). Free allowances will be distributed based on historical emissions with some use of benchmarking. The free allocations will also take into account planned changes to the size and scale of production that would significantly increase the emissions of the installation. There is a reserve of 89Mt to cater for new entrants to the scheme or significant unplanned increases in production.

Offset use will be set at 10% of allocation and allowances can be banked between phases, however regular CERs aren't eligible, they have to be CERs coming from Korean projects and issued since 2010. There are also limits on allowance borrowing which limit participants to borrowing 10% of the future year's allocation for the current year's compliance.

There has been strong opposition to the ambition of the scheme from carbon market participants. The 30% reduction by 2020 is not seen as viable and would hamper the South Korean economy. It is also an ambitious target in comparison with the more timid targets Russia, the United States, Japan and China have set themselves. As things stand the market is expected to be marginally short in the first phase.

Trading activity

To date the number of trades has been low with approximately 10 trades having gone through. This is caused by non-covered companies being banned from trading, by there being no significant forward market, very large free allocations and the risk of intervention by the Government (although the market would have to drop to 60% of its initial value or triple in price for anything material to happen).

Liquidity in the EU ETS was initially (and largely still is) driven by utility demand for longer term hedging (typically up to 3 years out) however in South Korea the electricity markets are not so well developed, operating as they do on a cost recovery model, and hence longer term hedging of carbon to hedge power sales is not a primary consideration.

It is early days for the Korean ETS and by ‘learning-by-doing' the demand and regulatory tweaks essential to make this a meaningful market will come with time.