Introducing Indonesia’s New Carbon Law.

Indonesia’s sweeping new carbon regulations introduce a general carbon tax policy, a general carbon economic value, sector-based emission caps, and a carbon trading framework.

Introduction

On 9 November 2021 at the United Nations Climate Change Conference (COP26) in Glasgow, President Jokowi affirmed Indonesia’s continued commitment to the Paris Agreement (Paris Agreement), announcing that he had signed Presidential Regulation No. 98 of 2021 on the Implementation of Carbon Economic Value to Achieve Nationally Determined Contribution Targets and Control over Greenhouse Gas Emissions in Relation to National Development (Regulation 98/2021), which, combined with Law No. 7 of 2021 on the Harmonisation of Taxation Regulations (Law 7/2021), sets out Indonesia’s carbon reduction road map (Carbon Road Map) towards net zero emissions (collectively, the Carbon Law).

The introduction of the Carbon Law is the next step in Indonesia’s plan to achieve its Nationally Determined Contributions (NDC) commitments to combating climate change under the Paris Agreement, which Indonesia ratified in 2016, and to achieve net zero carbon emissions by 2060.

New Carbon Law Principles

The Carbon Law is based on the following key principles:

1. Carbon Emissions Reduction Strategy: To achieve Indonesia’s carbon output goal of net zero emissions by 2060, the carbon emissions reduction strategy sets a minimum target of a 29% reduction of Indonesia’s carbon emissions by 2030 (up to 41% if the Government receives additional support from the international community).

2. Targeting of Priority Sectors: The Government will target carbon emission reductions from the Priority Sectors (as defined below) to cover approximately 97% of Indonesia’s total target NDC carbon emission reductions.

3. Development of Renewable Energy: The Government wants to synchronise the introduction of the Carbon Tax (as defined below) with the phasing out of coal, gas and biogas power plants and the introduction of new and renewable energy, such as waste-to energy, wind, solar, geothermal and other green energy sources. This aims to ensure a smooth energy transition and minimise the impact on business and the public.

4. Alignment of Government Policies: The Government will seek to ensure that the Carbon Tax and the carbon trading framework are consistent with and advance the NDC targets.

Carbon Tax: Who Does It Affect?

Under the Carbon Law, the new carbon tax (Carbon Tax) will be applied (in stages) to:

1. purchased goods that contain carbon; and

2. carbon producing activities that have a negative impact on the environment.

The Carbon Tax will be introduced in stages in line with the Carbon Road Map (described below) at a rate that will be no less than the market carbon price of CO2 equivalent. If the market carbon price is less than 30 rupiah per kilogram of CO2 equivalent, the carbon tax rate must be at least 30 rupiah per kilogram of CO2 equivalent. This benchmark rate is significantly lower than the 75 rupiah rate that the Government originally proposed, and is generally considered to be a political compromise to reduce the initial impact on Indonesia’s economy.

The Government intends to focus carbon emission reductions on certain priority strategic sectors – energy, forestry and transportation (Priority Sectors), covering around 97% of Indonesia’s targeted NDC carbon emission reductions.

The Carbon Law does not specify the goods and carbon producing activities to which the Carbon Tax will apply. However, we expect that the broad economic impact of the Carbon Law will be felt by all stakeholders in Indonesia, including Indonesian consumers, as the introduction of the Carbon Tax will almost certainly lead to increased costs for manufacturing, transportation, logistics and electricity, which businesses will no doubt seek to pass on to their customers.

In our view, the Indonesian stakeholders facing the greatest impact of the Carbon Law will likely be:

• energy sector: primarily coal-fired, diesel, and bio-gas power plants and businesses that produce, use or trade hydrocarbons;

• forestry sector: primarily the production and trade of goods from forest wood;

• transportation sector: primarily airlines, shipping, commercial transport and logistics businesses;

• manufacturing sector: primarily paper, steel and chemical manufacturers (but also other manufacturers using large amounts of electricity or producing high levels of carbon emissions);

• agricultural sector: primarily the farming of live animals (such as cows, pigs, goats and other livestock) producing high levels of methane gas and requiring large amounts of feed to maintain;

• waste management and treatment sector;

• construction and mining sectors; and

• Indonesian consumers.

Carbon Tax: When Does It Start?

The Carbon Road Map requires the Carbon Tax to be implemented in the following stages:

2022 to 2024: The Carbon Tax will initially be applied from 1 April 2022 only to coal-fired power plants, with an initial rate of 30 rupiah per kilogram of CO2 equivalent, and will then be subject to a carbon emission cap and tax system.

2025 onwards: The Carbon Tax will be expanded to cover all other relevant carbon producing sectors, including the other Priority Sectors, by taking into account the economic conditions, impact and scale of implementation of the Carbon Tax.

Carbon Trading Framework

The Carbon Law creates a legal framework for trading carbon so that Indonesian entities will be able to trade carbon credits with other local and foreign entities and offset their carbon emissions against certain activities which mitigate or reduce the impact of their carbon emissions.

The Carbon Law states that the Indonesian Government will establish a carbon trading bourse and issue further regulations to facilitate carbon trading in Indonesia. Under the carbon trading framework, there is expected to be a cap-and-trade system whereby carbon producing activities (and/or entities) are allocated certain carbon emission caps (Allocated Caps) that can be traded by business entities domestically and internationally. While it is not yet clear when the carbon trading bourse will be established, Government officials have indicated that a fully operational carbon trading market will be operational by 2025, in time for the next stage of the Carbon Tax.

The carbon trading framework also provides that entities (to be further identified) without Allocated Caps may offset their carbon emissions by providing an emissions reduction statement outlining their actions to reduce and mitigate carbon emissions, and the results of those actions. We expect that these arrangements will be subject to further implementing regulations. However, in practice, this mechanism may allow relevant businesses to convert emissions reduction statements into carbon credits that can be traded on the carbon trading bourse or be linked to results-based incentive payments, as discussed further below.

Results-based Incentive Payments

To encourage businesses (and national, regional and local governments) to actively reduce their carbon emissions, the Carbon Law introduces a results-based incentive payments mechanism. Under this mechanism, businesses that can provide verifiable evidence of (a) the results (and benefits) of their reduced carbon emissions or (b) the increase in their carbon reserves may qualify for a results-based payment. The Carbon Law describes three general types of results-based payments:

1. International Results-based Payments: made by international parties to the central or regional government, approved by the central government;

2. National Results-based Payments: made by the central government to regional and local governments, businesses and/or community groups; and

3. Provincial Results-based Payments: made by regional/provincial governments to local governments, businesses and/or community groups.

While the Carbon Law sets out the general legal framework for results-based incentive payments, further details are expected in the implementing regulations to be issued by the Ministry of Environment and Forestry.

Conclusion