Inverse price spread and illiquid trading in Korea-ETS

Abstract

The Korea Emissions Trading Scheme was formally launched in January 2015, aiming for a 30% reduction in South Korea's carbon emissions by 2030 from the business-as-usual levels. Under this trading mechanism, carbon allowance credits are traded on the Korea Exchange, while offset credits generated from emission-reduction projects are mostly traded over the counter. Exchange trading under the Korea Emissions Trading Scheme faced immediate liquidity problems a few days after its launch. Additionally, offset credits have been consistently traded at a much higher price on the over-the-counter market versus the exchange-traded allowance credits, a scenario opposite to the conventional wisdom. This article examines the causes of this inverse price relationship between these two types of credits as well as the lack of liquidity in exchange trading under the Korea Emissions Trading Scheme. Lessons learned from the Korean carbon market could have important implications for other countries seeking to adopt a similar system.