European Union Emissions Trading System (EU ETS)
What is the EU ETS?
The European Union Emissions Trading System (EU ETS) is a cornerstone of the EU’s strategy to combat climate change and reduce greenhouse gas emissions. It operates on a ‘cap and trade’ principle, setting a cap on the total amount of certain greenhouse gases that can be emitted by installations covered by the system. Within this cap, companies receive or purchase emission allowances which they can trade with one another as needed. The cap is reduced over time so that total emissions fall.
Established in 2005, the carbon pricing mechanism is the world’s first major carbon market and remains the largest one today. It covers approximately 36% of the EU’s total GHG emissions, including those from power and heat generation, energy-intensive industrial sectors, and commercial aviation within the European Economic Area.
How does the EU ETS work?
- Cap and Trade Principle: A cap is set on the total amount of certain GHGs that can be emitted by installations covered by the system. This cap is reduced over time so that total emissions fall. Within the cap, companies receive or buy emission allowances which they can trade with one another as needed. Each allowance gives the holder the right to emit one tonne of CO₂ or the equivalent amount of another GHG.
- Allocation of Allowances: Allowances are mainly auctioned, but some are allocated for free, particularly to sectors at risk of carbon leakage. The auctioning of allowances is the default method of allocation, with the power sector generally required to purchase all of their allowances.
- Trading: Companies that keep their emissions below their allowances can sell their surplus allowances to others that are facing difficulties in keeping their emissions in line. This provides flexibility for companies to manage their emissions in the most cost-effective way.
- Compliance: At the end of each year, companies must surrender enough allowances to cover all their emissions, otherwise heavy fines are imposed. If a company reduces its emissions, it can keep the spare allowances to cover its future needs or sell them to another company that is short of allowances.
Timeline of the implementation
The EU ETS has evolved significantly since its launch in 2005. The EU developed different phases to address climate challenges, adapt to economic shifts, and strengthen carbon pricing mechanisms. Each phase introduced improvements, expanded scope, and aligned the system with EU climate goals. From a pilot initiative to a cornerstone of EU decarbonization, the phases reflect lessons learned in implemeting a carbon pricing mechanism. Here’s an overview of the key developments in each phase.
Which sectors are covered by the EU ETS?
The carbon pricing mechanism covers the following sectors:
- Energy Sector: Power and heat generation.
- Industry: Energy-intensive industries such as oil refineries, steel works, and production of iron, aluminum, metals, cement, lime, glass, ceramics, pulp, paper, cardboard, acids, and bulk organic chemicals.
- Aviation: Commercial aviation within the European Economic Area.
- Maritime Transport: From 2024, the EU ETS will include emissions from maritime transport, covering ships above 5,000 gross tonnage.
Price development of EU ETS certificates
The price of EU ETS certificates has experienced significant fluctuations since the system’s inception, influenced by economic conditions, policy reforms, and market dynamics. These price variations are essential for sectors regulated under the system, as they directly impact operational costs and investment decisions. Higher certificate prices incentivize companies to reduce emissions and invest in cleaner technologies, while lower prices may lessen the urgency for such investments. Understanding the historical and projected price trends of EU ETS certificates is important for stakeholders to ensure effective financial planning.
The grafik below shows the price development since the second phase (2008).
Source: Carbon Price Viewer – Sandbag
Conclusion and future outlook
The EU ETS has proven to be an important tool in reducing emissions and incentivizing clean technology adoption. Stricter caps and an ambitious EU climate policy will likely lead to steadily rising certificate prices. Future phases will expand the system’s scope, including sectors like maritime transport and enhancing the Market Stability Reserve. Stakeholders must adapt to evolving dynamics, leveraging innovation to remain competitive in a decarbonizing economy. The carbon pricing scheme will continue shaping global climate policy as a model for market-based carbon regulation. Its success is vital for achieving EU’s 2050 climate neutrality goals.
