Carbon pricing in Asia: Examining emissions trading systems and carbon taxes

Executive Summary

Carbon pricing is based on the principle that emitters should pay for the damage caused by their greenhouse gas (GHG) emissions. Asia accounts for over 50% of annual GHG emissions, and faces critical challenges in creating carbon pricing mechanisms to drive decarbonization and help meet climate goals. Although several Asian countries have established carbon taxes or emissions trading systems (ETSs), the prices are still far lower than the estimated USD50–USD100 per tonne of carbon dioxide equivalent (tCO₂e) required by 2030 to meet the targets of the Paris Agreement. Current regional prices remain below USD20/tCO₂e, which is too low to achieve significant emission reductions or encourage substantial investment in clean technologies.

Various challenges hinder the efficiency and effectiveness of Asia's carbon markets. The main issue is the oversupply of allowances, driven by overly generous allocation methods, limited sectoral coverage that reduces participation and demand, unambitious targets, and the persistence of fossil fuel subsidies. In the initial phases of their ETS implementation, countries like China and South Korea have generously allocated free allowances, leading to a market surplus and reduced prices. This contrasts with the European Union (EU), which has increasingly moved towards auctioning more than 50% of its allowances. Another challenge is the limited sectoral coverage of these schemes. Most carbon pricing systems concentrate on the power sector, leaving significant emissions from buildings, agriculture, and transportation largely unpriced. China is broadening its ETS to include heavy industry, and South Korea's system covers over 70% of national emissions. However, a comprehensive, economy-wide application is still absent.

Additionally, many systems set unambitious targets. For example, China's national ETS uses an intensity-based cap, limiting emissions per output unit, rather than setting an absolute cap on total emissions. This design increases total emissions as the economy grows, is less effective, and more costly than the absolute caps utilized by the EU and South Korea. Pervasive fossil fuel subsidies, which actively work against carbon price signals, compound the problem. In 2022, these subsidies amounted to USD1.25 trillion globally. The East Asia and Pacific regions had the largest subsidy share, undermining the financial incentive to decarbonize.

According to studies examining sectoral marginal abatement costs, a wide range of carbon prices could drive decarbonization. A multifaceted strategy is necessary to transform carbon pricing into an effective decarbonization tool. Policymakers should adopt a phased yet ambitious approach, starting with a modest carbon price of USD15–USD25/tCO₂e and then implementing a predictable annual increase of USD10–USD15/tCO₂e for investment certainty. This should be accompanied by eliminating fossil fuel subsidies, with savings redirected to climate projects and social safety nets (such as universal cash transfers), to protect vulnerable households from rising energy costs. Studies indicate that recycling carbon revenue in this way can make carbon pricing a progressive policy that reduces poverty and inequality.