Report on Transition to Carbon Neutrality

Capital Flows, Resource Circulation, and International Collaboration Are Key

Japanese version: May 30, 2023

Mitsubishi Research Institute, Inc.

Tokyo (May 30, 2023)—Mitsubishi Research Institute (MRI) published a report on Japan’s transition to carbon neutrality. Based on in-house scenario analysis, MRI has identified the key factors for smoothly shifting society to a decarbonized model while maintaining economic security and growth. With the country's 2050 carbon neutral targets set, MRI aims to guide the country toward its goals, first by shedding light on the steps needed to get there.

The following is an overview of the report:

International community increasingly fractured, road to carbon neutrality increasingly uncertain

The Communique from the May 2023 G7 Summit in Hiroshima touched upon the latest report from the Intergovernmental Panel on Climate Change (IPCC). This report stated that human activities have already caused global warming to 1.1°C above pre-industrial revolution levels and this has led to widespread adverse impacts and related losses and damages. There is very little time left to combat climate change.

However, the transition to a decarbonized society is not progressing steadily. We have yet to achieve structural solutions to the energy market disruptions caused by the invasion of Ukraine. As well as the antagonism between the US and China, the Global South grouping of countries has started to assert themselves on the world stage in recent years and it is increasingly difficult to develop the international coordination and rules needed for decarbonization. From the perspective of decarbonization and economic security, the rebuilding of supply chains is also an important challenge for the private sector.

In the face of such mounting challenges, the road to decarbonization looks uncertain if based on idealistic or optimistic discussions alone. We need to define a vision for a realistic transition to carbon neutrality that does not damage economic security or economic growth.

Basic transition scenario is two-pronged approach of behavior change and technological innovation

When analyzing scenarios for the transition to carbon neutrality, we can see that behavior change will play a key role through 2030, and technological innovation and roll-out across society will play key roles through 2050. When looked at from the perspective of end consumption, broadly speaking we see gradual progress in restructuring in the buildings, transport, and industry sectors. In the buildings sector, electrification and decarbonization of power generation will make significant contributions, while in the transport and industry sectors, these moves combined with measures in non-energy domains will boost contributions to reduced CO2 emissions. Decarbonization of generation should not be skewed towards a particular source because of the technological characteristics of zero-emission energy sources (renewables, decarbonized thermal power, and nuclear power) and the different energy- and economic security-related risks.

Rising temperatures correlate with cumulative emissions, not emissions in a single year, so everything will not necessarily be fine if carbon neutrality is achieved just in 2050. Reducing cumulative emissions through early measures also means pursuing behavior change now and connecting this with subsequent technological innovation. Moreover, at the same time as this change in energy supply/demand structures, we need to also progress change in industrial structures. The automotive and energy-related industries will be impacted significantly, and we also need to encourage labor mobility at the right time to support this restructuring.

Capital flows, resource circulation, and international collaboration are key to a smooth transition

To achieve a smooth transition, Japan needs to find a way forward with the following issues: How can Japan connect behavior change and technological innovation? As industry structures change, how can Japan ensure economic growth in a decarbonized society? And, as the global balance of power changes, how can Japan ensure energy and economic security? These questions are not easy to answer. We propose three factors that we think provide a key approach for Japan: (1) capital flows, (2) resource circulation, and (3) international collaboration.

(1) Capital flows: Need appropriate carbon pricing to help connect behavior change with technological innovation

To achieve a smooth transition to a decarbonized society, Japan must promote capital flows into the necessary domains and achieve a shift to decarbonized industrial structures and economy. We expect carbon pricing to (1) promote demand-side behavior change by making the price of carbon visible and (2) support government revenues to provide the investment needed for R&D into decarbonized technologies and social roll out. We think carbon pricing has the potential to bridge the gap between behavior change and technological innovation.

For behavior change, the question currently being debated is whether carbon pricing can promote enough change in behavior. In questionnaire-based research with corporate and consumer respondents, only 15–40% of consumers and companies thought that behavior would be changed if the carbon price was set at the currently expected level of JPY2,000/tCO2. Looking at the situation overseas, we can see that the carbon price needs to be set at the right level to drive behavior change.

For technological innovation, the public and private sector are expected to invest a total of JPY150 trillion over the next 10 years under the GX Promotion Act that came into force in May 2023, but our estimates suggest that investment to actually decarbonize will need to be stepped up after 2030, reaching a cumulative total of at least JPY320 trillion by 2050, particularly for renewable energy and next-generation automobiles. We look for proactive government involvement, as well as clarification on the medium- and long-term outlook for carbon pricing in order to improve private sector investment predictability.

(2) Resource circulation: Need to secure decarbonized resources and also decarbonize materials fields

Resource circulation is an important approach for a country like Japan that lacks natural resources. The resources and manufactured products needed for decarbonization are being designated as strategic materials, and interest levels are running particularly high for metal resources. The metals that are included in critical minerals lists in Japan, the US, and Europe include some that are vital for decarbonization (used in renewable energy, storage batteries, and hydrogen manufacture). Such metals tend to be produced by only a handful of countries and are available on oligopolistic markets. Resource circulation has the potential to reduce the import volumes needed in the future and diminish risks to economic security.

Resource circulation can also be effective in reducing CO2 emissions in hard-to-abate materials fields. For example, in the chemicals industry, it is expected that aggressive circulation of plastics could cut emissions by a further 20%. Japan needs to push ahead with resource circulation, working to appropriately quantify the emissions reductions achieved through individual initiatives, while also heeding the potential risks if this backfires (i.e., CO2 emissions rise).

(3) International collaboration: Key to new growth may lie in building energy systems that go beyond domestic boundaries and turning Japan into an investment-driven nation

International collaboration will be increasingly important for global decarbonization and future economic growth in Japan, and also from the perspective of economic security. Direct investment by Japan in ASEAN nations is rising each year and is currently running at twice the level of investment made by China, but ASEAN nations are also becoming increasingly reliant on the global superpower nations of the US and China.

Analysis of international trade models shows that if high carbon prices are introduced without the necessary structural changes in energy systems, industry competitiveness and economic security may be impacted in Japan and in ASEAN nations, for example due to a decline in trade balances and increasing reliance on specific countries for imports. From the perspective of economic security and economic growth therefore, it may become increasingly important for Japan to build complementary relationships with ASEAN nations just starting to decarbonize.

It is no easy matter to become carbon neutral and we hope Japan will look beyond its own domestic boundaries and take a broad perspective to the optimization of its energy systems, starting with collaboration with ASEAN nations. Using decarbonization as an opportunity, Japan should move away from its focus on trade and strengthen its position as an investment-driven nation. By leveraging the technological capabilities developed to date, we think Japan could build a new growth strategy through highly efficient and productive investments in other countries and industrial sectors.

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