Publication date: Feb 5, 2026 

Japan’s ETS Takes Shape: FY2026 Rule-Making Will Define Future Carbon Costs for Power and Industry

From April this year, Japan will take a decisive step into carbon pricing with the launch of its first full-scale emissions trading system (ETS). Covering an estimated 300 to 400 companies and nearly 60% of national greenhouse gas emissions, the scheme immediately becomes a core feature of the power and industrial landscape. While the government plans a phased rollout, the ETS will begin reshaping cost structures, contracting strategies, and risk management across generators, retailers, traders, and large consumers from day one.

The ETS Will Apply to 100,000-Ton CO₂ Emitters, With Tradable Allowances Set Under Sector Caps

The ETS will cover companies with average annual emissions of 100,000 tonnes of CO₂e or more over a three-year period, with power generators becoming subject to mandatory participation from FY2033. The government will set sector-specific emissions caps in line with predefined reduction targets and allocate emissions allowances to companies within those caps. Companies that exceed their caps can purchase additional allowances from other market participants, while those with surplus allowances may sell them (METI). 

Emissions allowances will be determined either by the benchmark approach (which will apply to roughly 90% of the participants) or by the grandfathering approach. In the manufacturing industry, for example, sector-specific benchmarks for steel, cement, and automobiles will be set based on CO₂ emissions intensity per unit of output, and allocation volumes and compliance burdens will be determined by comparing these benchmarks with each company’s actual performance. Companies with higher energy efficiency are favored even at the same level of output, while those with lower carbon efficiency bear higher costs, encouraging companies to invest in decarbonizing their businesses. For power generators, fuel-specific benchmarks (e.g., coal and gas) will apply for the initial three years from FY2026. However, from FY2033, the system shifts to an emissions-based approach, requiring all generators to purchase allowances based on their emissions levels. 

ETS Price Floor and Cap Will Be Set by J-Credit Benchmarks and Coal-to-LNG Switching Costs

For FY2026, the floor price will be set at JPY 1,700/ton of CO2, which is based on energy-efficiency J-Credit market prices before their recent surge, while the cap price will be JPY 4,300/ton, benchmarked to the historical fuel-switching cost between coal and LNG power in order to promote modernization of inefficient power plants. METI also presented an outlook for price ranges from FY2027 onward. The price cap and floor will increase each year by 3% (plus the projected annual inflation rate) to incentivise decarbonisation efforts, with the upper limit expected to reach JPY 4,840 and the lower limit reaching JPY 1,913 by FY2030. The actual upper and lower levels will be determined on a year-by-year basis.

Look Out Next for ETS Rules on Allowance Banking and Cost Pass-Through

With the ETS trading market set to launch in the autumn of 2027, the government must advance the detailed design of the market throughout FY2026. According to Keigo Akiyama, a senior researcher and a member of METI’s Subcommittee on the Emissions Trading System (ETS), a key issue will be the extent to which companies will be allowed to carry over surplus emissions allowances over the long term and borrow allowances from future compliance periods. These behaviors will certainly influence liquidity and price volatility. If companies continue to hold excessive amounts of allowances, it could drive up prices. In order to encourage rational corporate behavior, the range of banking should be carefully examined (Nikkei GX). Additionally, guidance on cost pass-through to wholesale and retail electricity prices will directly shape commercial outcomes for generators, retailers, and consumers.

Shulman Commentary:The ETS is now moving from high-level policy into detailed market design. During FY2026, decisions on allowance allocation, price floors and caps, banking rules, and cost pass-through will be set, shaping future carbon cost exposure, market liquidity, and price volatility, even before trading begins. For power generators, retailers, traders, and large consumers, the key issue is how these rules will interact with fuel choices, contracting strategies, and wholesale and retail pricing. Early analysis during the design phase will be essential to identify cost risks and strategic options before the market becomes operational.

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