Posted on 13 Jun 2025
Introduction
During the announcement of the Malaysian budget in October 2024, Prime Minister announced that carbon tax will be introduced in 2026 and this will apply to the energy and iron and steel sectors. No further information was provided about the carbon tax. So, what can it be?
This article looks at a few tax related carbon pricing mechanisms that are prevalent in the world today. Then we will look at what’s going on in ASEAN on the development of carbon pricing mechanisms.
What are the Common Variants?
Globally there are 2 main variants of carbon tax related pricing, commonly known as a direct carbon tax and an emissions trading system (ETS), also known as a cap-and-trade system.
The Direct Carbon Tax
A direct carbon tax is a fixed tax imposed on carbon emissions generated, typically charged per tonne of greenhouse gas or CO₂-equivalent (tCO₂e) emitted. The three largest sectors that generate significant emissions are energy, transport and industry, including the steel industry. The amount of carbon tax is set by the government, usually at a lower rate that will increase over time.
A good example in ASEAN is the Singapore carbon tax. Companies that emit at least 25,000 tonnes of carbon dioxide equivalent are required to pay carbon tax. This started with SGD 5 /tCO2e (USD 3.70) in 2019 and is now at SGD 25/tCO2e (USD 18.70). In 2026, the tax will be SGD 45 /tCO2e (USD 33.60) before reaching SGD 50 – 80 /tCO2e (USD 37.30 – 59.70) by 2030. These prices are set by the government.
Carbon taxes usually cannot be offset with carbon credits. However, in Singapore’s case, companies are allowed to high quality international carbon credits (ICCs) to offset up to 5% of their taxable emissions from 2024. This will help cushion the tax impact for companies that are able to source for eligible carbon credits in a cost-effective manner, help to create local demand for high-quality carbon credits, and catalyse the development of well-functioning and regulated carbon markets.
In Singapore’s case, the Authorities have reported that the carbon tax revenue collected will be used to support decarbonisation efforts, the transition to a green economy, and to cushion the impact on businesses and households.
Key Characteristics of Direct Carbon Tax:
Feature | Details |
Price Setting | Fixed price per ton of emissions set by the government |
Market Influence | No trading, no price fluctuation, no offsets (unless allowed by the government) |
Revenue Usage | Governments decide how to use tax revenue |
Flexibility | Less flexible; no market mechanism |
Certainty | Provides price certainty but uncertain emissions reduction |
Complexity | Simple to administer |
Other examples of Direct Carbon Tax
Emissions Trading System (ETS), also known as the Cap-and-Trade System
An ETS is based on a cap-and-trade system that sets a cap on emissions but allows companies to trade emissions permits in a market-based system. Companies that emit more than their caps must buy emission permits from companies emits below their caps. The caps may be different for each company or group of companies.
The ETS system is a complex system that needs further explanation. The largest and longest functioning ETS is the European Union ETS (EU-ETS) and it operates on the following basis:
Cap: The EU-ETS cap is the limit on emissions that a business is permitted to emit. It is also known as emission allowances. The cap is set by the government, and may be reduced over time. Caps are different for the different sectors (energy, transport, industry) and industrial groups (for steel: blast furnace-basic oxygen furnace – BF-BOF, electric arc furnace – EAF, direct reduced iron -DRI).
Allowance: One unit of allowance equals to the permit to emit 1 ton of greenhouse gas (GHG). Allowances were introduced to prevent carbon leakage from imports. Allowances are either allocated for free or auctioned.
Benchmarks: Caps or allowances are set against the EU benchmarks, which is based on the average greenhouse gas emissions of the best performing 10 % of installations producing that product in the EU.
Exemptions: Companies who are required to trade their emissions on the EU-ETS are generally exempted from paying carbon tax. Those not in EU-ETS may be subject to carbon tax.
So how does the process work?
Key Characteristics of ETS:
Feature | Details |
Price Setting | Market-based (supply and demand of allowances) |
Market Influence | Full trading system allows price flexibility |
Revenue Usage | Auction revenues can be reinvested in green projects |
Flexibility | Highly flexible; companies can trade or invest in reductions |
Certainty | Certainty on emissions limit but not on price |
Complexity | High complexity |
Other Examples of ETS:
What are the Other Variants?
The Cap-and-Tax System or Cap-Trade-and-Tax System (“Cap-and-Tax”)
The only Cap-and-Tax System in the world was launched in Indonesia in February 2023 for the power generation sector.
The new system will cover facilities with a production capacity of more than 100 MW, though smaller coal and fossil fuel plants may also be included at a later point. The system will initially cover 99 coal-fired power plants that account for 81.4% of the country’s national power generation capacity. These facilities belong primarily to the state-owned electricity company, Perusahaan Listrik Negara (PLN). The government will establish intensity targets, which determine the number of allowances each facility receives for every MWh of electricity generated. It is estimated that allowances worth a total of 20 million tCO2e will be allocated.
This system is similar to the EU-ETS system. The only difference is that the current scheme only applies to the power generation sector in Indonesia and any excess emissions after the trade is completed (deficit less surplus emissions), will be subject to carbon tax. The EU-ETS system does not allow such excess emissions; companies must fully offset their emissions with carbon credits or be heavily fined.
This system will be implemented in three phases. The first phase will run from 2023 to 2024 and only cover coal-fired power plants. In the second (2025-2027) and third (2028-2030) phases, the government plans to expand the coverage of the ETS to oil and gas-fired power plants and other coal-fired power plants not connected to PLN’s grid.
The system will eventually be expanded to more high emission sectors, and it will eventually evolve into an ETS.
What are the Details Need to be Considered?
There are other fine details that need to be considered:
Gases: What gases are measured in the measurement of greenhouse gas emissions? For Singapore, the greenhouse gases (GHGs) covered are Carbon dioxide (CO2), Methane (CH4), Nitrous oxide (N2O), Sulphur hexafluoride (SF6), Nitrogen trifluoride (NF3), Hydrofluorocarbons (HFCs) and Perfluorocarbons (PFCs). Meanwhile, the EU-ETS system only covers Carbon Dioxide (CO2).
Scopes: Both Singapore and the EU-ETS system only covers scope 1.
Sectors: The Singapore carbon tax covers all facilities emitting more than 25,000 tonnes of greenhouse gases while the EU-ETS have similar requirements but is initially focused on power production and certain industrial sectors (oil refineries, steelworks and the production of iron, aluminum, metals, cement, lime, glass, ceramics, pulp, paper, acids, and bulk organic chemicals) and intra-European flights. This has recently expanded to cover the maritime shipping industry and will eventually cover Buildings, Road Transportation, and Agriculture (by 2027). For now, Indonesia’s cap-and-tax system only cover power generation industry.
This section is not meant to be exhaustive, but the details could vary significantly between countries. Because the EU-ETS system is the largest and most well established to date, many countries would like to make their own ETS system interoperable with the EU-ETS. Given the complexity of the ETS system, it would be a challenge to link the systems together.
Conclusions
Carbon pricing is a complex topic. Governments have been navigating very cautiously about introducing carbon tax due to cost implications to both industry and citizens. Details about the perils of carbon tax was published in the April 2024 issue of the ASEAN Iron and Steel journal.
So, back to the original question: how would the Malaysia carbon pricing mechanism look like? For simplicity, it could start with carbon tax first then eventually move towards the more complicated emissions trading system, just like how this has evolved in many countries.
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Source:SEAISI
