On September 29, 2020, the Ministry of Environment (the “MOE”) announced the finalized “National Greenhouse Gas Emission Permit Allocation Plan for the Third Planning Period (2021-2025)” (the “Phase 3 Allocation Plan”).  The MOE prepared the Phase 3 Allocation Plan to reduce emission levels in line with the reduction targets of the National Greenhouse Gas Reduction Road Map (the “Road Map”).  Key details of the plan are as follows: 
 

1.   Major Changes in the Phase 3 Allocation Plan
 

2.   Overview of Allocation Scope and GHG Emission Permit

• [Allocation Scope] During the Third Planning Period, around 3 billion tons (annual average of about 609.7 million tons) worth of emission permits will be allocated to 681 companies falling under 69 business types in six industries that are subject to the allocation.

• [Sectors and Business Types Subject to Allocation] The six sectors (i.e., power, industry, transport, buildings, waste, and public and others) included in the previous plan have been kept for the Third Planning Period.  Meanwhile, 11 business types (e.g., construction, railways, land passenger transport, marine transport, waste dismantlement and raw material recycling) have been added, while four business types (e.g., insurance) have been excluded.

• [Total GHG Emissions Quota] To ensure consistency with the Road Map, the government plans to allocate (i) around 616 million tons worth of emission permits per year between 2021 and 2023, and (ii) around 599 million tons worth of permits per year between 2024 and 2025.  The figures represent about a 4.7% reduction in the total volume of GHG emissions compared to that of the reference period (2017-2019) and a 4.0% reduction compared to the Second Planning Period.

3.   Paid Allocations and Change in Allocation Criteria

• [Paid Allocations] For the Third Planning Period, the ratio of paid allocations will be raised from 3% to 10%.  Accordingly, for 41 business types (out of 69) that are subject to paid allocations, 90% of the total allocated emission permits will be granted free of charge, but the remaining 10% must be purchased through the auction process.  Companies within the remaining 28 business types, whose international trade intensity multiplied by production cost incurrence rate is below 0.2%, will receive 100% of the allocated emission permits for free.  As a result of the new allocation criteria, five more business types (including automobiles, textiles and aircraft manufacturing) will be subject to paid allocation.

• [Allocation Method] For the power sector, the MOE has decided to improve the BM, taking into account the upcoming change to the electricity dispatch regime whereby GHG emissions costs will affect the priority of the power generators to operate.  The MOE will adopt a phased approach to allow enough time for the sector to adapt to the new allocation method.

• [Strengthened Functioning of the Market] Aiming to boost emission permit trading, the MOE has allowed financial institutions, securities companies and individual investors to participate in the emission permit trading market from 2024.  In the past, trading was limited to companies subject to emission permit allocation and to market makers such as Korea Development Bank and the Export-Import Bank of Korea.  With the restriction removed for the Third Planning Period, financial institutions and others will be allowed to trade emission permits.

4.   Flexibility Mechanism and Heightened Approval Requirements for External Projects

• [Restriction on Carry-Forwards] To mitigate the hoarding trend of excess emission permits, the amount of permits allowed to be carried forward by a company to the subsequent year will be restricted to (i) twice the company’s net sales amount of emission permits in the first and second years and (ii)  the company’s net sales amount of emission permits in the third and fourth years.  The amount of emission permits that can be carried forward from the Third to the Fourth Planning Period (2026-2030) will be restricted to the company’s average net sales amount of emission permits during the Third Planning Period.

• [Limit on Offset Credits] In order to limit excessive reliance on offset credits, the amount of offset credits (whether domestic or foreign) a company may submit to the MOE will be limited to 5% of the total emission permits to submit.

• [Heightened Approval Requirements for External Projects] If a new climate regime is established in accordance with the Paris Agreement, only projects that comply with the new climate regime will be approved as external projects that can generate offset credits.  In order for the emission reductions achieved by an approved external project to be certified as offset credits, companies must file an application for certification within three years of achieving the reduction (for reductions achieved prior to January 1, 2021, the application should be filed by December 31, 2022).  Once certified, the amount of emission reductions should be converted to Korean Credit Units (“KCUs”) within two years from the certification date (emission reductions certified prior to or on December 31, 2020 must be converted to KCUs by December 31, 2022).

5.   Allocation Timeline and Action Plans

• By the end of October 2020: Application for allocation by companies.
• By the end of December 2020: The MOE completes the allocation of emission permits.
• By the end of January 2021: Appeals against the allocation are filed to the MOE.

Overall, the GHG Emission Permit Allocation Plan for the Third Planning Period has been strengthened in many aspects compared to that of the Second Planning Period, and we expect it to bring about significant changes to various aspects of the credit allocation scheme (e.g., allocation method, flexibility mechanism, scope of entities that are allowed to trade emission permits).  As the new regulations may significantly increase compliance costs, we advise companies to optimize the use of allocated emission permits, as well as monitor and respond to amendments to laws and regulations concerning the implementation of the emission permit trading scheme.