TOKYO, July 12 (Reuters) – Japan’s climate bill, which backs the creation of an emissions trading scheme, faces an uncertain fate after the ruling Democratic Party and its ally lost their majority in a weekend election for parliament’s upper house.

Prime Minister Naoto Kan’s Democratic Party of Japan (DPJ) stays in power because it controls the more powerful lower house, but will need to seek new partners to control the upper chamber and pass bills smoothly.

The ruling bloc at present does not have a two-thirds majority in the lower house that is needed to override decisions made in the upper house.

Japan is the world’s fifth-biggest greenhouse gas emitter and has pledged to cut greenhouse gas emissions by 25 percent from 1990 levels by 2020.

The target is among the most ambitious of all rich nations but has also sparked nationwide debate over how to attain it without hurting the world’s No.2 economy. [ID:nTOE63I04R]

The climate bill, shelved last month after parliament ran out of time to finish debate, would make the target legally binding and set a one-year deadline for the government to design a compulsory emissions trading system. Other measures to help Japan meet the target are also part of the bill. [ID:nTOE65L09F]

Below are some scenarios for the climate bill, which the government plans to resubmit to the next session of parliament.

BILL PASSES IN CURRENT FORM

Prospects: Possible

The government plans to resubmit the climate bill in its current form in the next session of parliament, for which a start date has not been decided.

The DPJ could, in the meantime, woo one or more smaller parties into the ruling coalition to cobble together an upper house majority, clearing the way for smooth passage of the bill.

Even without joining the coalition, some opposition parties who favour tougher climate policy to boost the clean-energy sector could agree to help the DPJ pass the bill, although they could drive hard bargains and stall debate.

The climate bill calls for the government to draft separate legislation to design a mandatory emissions trading system within a year, so any delay could stall those plans.

Currently, Japan only has a voluntary carbon market at the national level based on companies’ pledged goals, which are mostly caps on emissions per unit of production and leave room for rises in emissions when output grows.

When trading under the new scheme will actually start has been unclear, with analysts divided between 2012 and 2013.

BILL PASSES, BUT WATERED DOWN

Prospects: Possible

The DPJ could be forced to water down the bill in exchange for help from the opposition to implement strategically more important policies such as fiscal reform and overhauling the social security system.

Climate policy has not been a big focus for voters, so the DPJ might want to spend its energy making progress on other issues to build up public support ahead of a general election that must be held before late 2013.

The weekend’s weak election outcome could also force the DPJ to listen more to demands from industry and labour groups which are against tougher climate policies because of the possible impact on jobs.

The bill has already been watered down from earlier drafts compiled by the Environment Ministry. The latest bill calls for the emissions trading system to set volume caps in principle but also “consider carbon intensity”, which leaves room for the scheme to allow companies to emit more when output grows.

BILL STALLS

Prospects: Possible

If the DPJ fails to pass the bill in the upper house, the bill will stay stuck in parliament.

The government will likely stick to its tough 2020 emission reduction target but it would lose political momentum for a mandatory emissions trading scheme, which analysts say is key for Japan to achieve deep cuts in domestic emissions.

Failure to pass the bill could also weaken Japan’s bargaining power at a U.N. climate meeting in Mexico from Nov. 29-Dec. 10 that aims to try to seal a tougher global agreement on fighting climate change. (Editing by David Fogarty)