The EU Emissions Trading System:
- Set up in 2005, is the world's first international emissions trading system.
- Operates in all EU countries plus Iceland, Liechtenstein and Norway.
- Limits emissions from around 10,000 installations in the power sector and manufacturing industry, as well as airlines operating between these countries.
- Covers around 40% of the EU's greenhouse gas emissions.
The EU ETS works on the 'cap and trade' principle. A cap is set on the total amount of certain greenhouse gases that can be emitted through the installations covered by the system. The cap is reduced over time so that total emissions fall. Within the cap, installations buy or receive emissions allowances, which they can trade with one another as needed.
After each year, an installation must surrender enough allowances to cover its emissions fully, otherwise, heavy fines are imposed. If an installation reduces its emissions, it can keep the spare allowances to cover its future needs or sell them to another installation that is short of allowances.
Trading brings flexibility which ensures emissions are cut where it is cheapest to do so. A robust carbon price also promotes investment in innovative, low-carbon technologies.
The EU ETS covers the following sectors and gases:
- Carbon dioxide (CO2) from
- electricity and heat generation,
- energy-intensive industry sectors including oil refineries, steel works, and production of iron, aluminium, metals, cement, lime, glass, ceramics, pulp, paper, cardboard, acids and bulk organic chemicals,
- commercial aviation within the European Economic Area.
- Nitrous oxide (N2O) from the production of nitric, adipic and glyoxylic acids and glyoxal;
- Perfluorocarbons (PFCs) from the production of aluminium.
The recent updates to the ETS agreed upon at the end of 2022 include:
- The agreement will reduce emissions from the EU ETS sectors by 62% by 2030 compared to 2005 – a substantial increase from the 43% targeted reduction under previous EU legislation
- In meeting that target, the speed of annual emissions reductions will also increase, from requiring 2.2% per year reductions under old legislation to 4.3% reductions per year from 2024 to 2027, and 4.4% annual reductions thereafter
- The Market Stability Reserve, which stabilises the carbon market by removing surplus allowances, will be strengthened by prolonging beyond 2023 the increased annual intake rate of allowances (24%) and setting a threshold of 400 million allowances.
- Free emission allowances will be phased out in certain sectors between 2026 and 2034, with the CBAM brought in instead to protect those sectors from carbon leakage (cement, aluminium, fertilisers, electric energy production, hydrogen, iron and steel, as well as some precursors and a limited number of downstream products). The free allowances will be phased-out at a slower rate at the beginning and an accelerated rate at the end of this period.
- For the first time, shipping emissions will be covered by the ETS. There will be a gradual introduction of obligations for shipping companies to surrender allowances: 40% for verified emissions from 2024, 70% for 2025 and 100% for 2026. The regulation will apply to most large vessels (over 5000 gross tonnages) from the start and will be phased in for smaller vessels.
- A new separate ETS will commence operation in 2027 to cover fuels used in road transport and heating buildings. The new system will apply to distributors that supply fuels to buildings, road transport and certain other sectors. Emissions will be expected to fall by 5.10% annually on introduction in 2024, and by 5.38% annually from 2028.
Further information: EU ETS, Fit for 55: reform of the EU emissions trading system