In the EU ETS, regulators issue and sell EUAs through auctions - EU ETS revenues are centralized and then redistributed. See more on the carbon market auction procedures in this article.
The European Union Emission Trading Scheme (EU ETS) was put in place following the Kyoto Protocol - it is a European policytool aiming to reduce carbon emissions. Under the scheme, each tonne of CO2 must be matched to a European Union Allowance (EUA). As the price of EU ETS rises, companies are incentivized to reduce their carbon footprint by investing in decarbonization efforts. The aim is to make sustainable investments economically more appealing than bearing the costs of carbon allowances.
As seen in our guide on carbon cap and trade systems, there is a primary and a secondary market within the EU ETS framework. The primary market is when the European commission issues EUAs through auctions (or gives them away for free). The revenues from these auctions is then centralized and redistributed according to specific mechanisms. They amounted to €152 billion between 2005 and 2022.
An emissions trading system (ETS) is a market-based mechanism for reducing greenhouse gas emissions - the objective is to ascribe a cost to each tonne of CO2 emitted. It works by setting a cap on the total amount of emissions that can be released by a group of industrials, such as power plants or factories. Those can receive for free, bid for, or trade emission allowances. At the end of the year, polluters have the obligation to surrender a number of allowances equivalent to their emissions.
The European Energy Exchange (EEX) is the standard auctioning platform for all member states participating in the EU ETS, except for Germany and Poland (they have opted for separate national auctions). Auctions are conducted daily from 9 am to 11 am CET, and the outcomes are made public on the EEX's website. The proceeds from the issuing of EUAs are centralized and then redistributed to individual countries. A proportion is kept for the Innovation and modernization funds (read more below).
The auction process is a “single-round, sealed bid, uniform price auction”. Each bidder indicates the quantity of allowances they wish to purchase and the corresponding price they are willing to pay. The bidding period lasts for a minimum of two hours. Then, the auction platform calculates and discloses the auction clearing price, the point at which the demand for allowances matches the quantity offered for sale on that particular day. Successful bidders are those who placed bids at or above this clearing price. Regardless of their initial bid amounts, all successful bidders pay the same price.
Between 2005 and 2022 €152 billion were generated from the auctioning of EUAs. Currently, 90 % of the auctioning revenues are redistributed to member states. The remaining 10% of the proceeds go to the innovation fund and the modernisation fund.
Climate change deteriorates human health, infrastructures, it causes mass migration, famines… A lot of financial resources are required to address and repair those damages. The World bank has stated that an annual investment of $5 trillion is needed by 2030 as a response to global warming. In this context, carbon markets are one of the ways to raise the necessary funds to keep tackling climate change - the EU ETS, while directing a massive amount of capital towards climate projects, participates in bridging this finance gap to address global warming.
The European Law makes it mandatory for Member states to spend at least 50% of EU ETS proceeds to finance climate projects. Yet, most countries are using almost all of their proceeds for such projects, as seen in the graph below.
The EU energy agency reported that in 2022 an average of 76% of revenues was spent by member states for climate and energy purposes.
Many climate related projects are seeing the day thanks to financing from the EU ETS auctions. The NGO Emission Trading Extra, committed to advocating for emission trading schemes, has conducted a series of interviews to highlight initiatives funded through the EU ETS.
Until 2018, France has spent all of its auctioning revenues for climate action. It uses all of the EU ETS auction proceeds for a program called “ma prime renov” - a subsidy designed to assist in funding energy renovation projects. The grant amount is determined based on both income and the nature of the renovations.
After 2018, the amount invested in this program was capped by the government, and the remainder of the revenues from the EU ETS auctions for France go into the general public budget.
Italy used 50% of the revenue from the EU ETS to finance climate projects, the remaining of the proceeds going to the general budget. Here are some examples of projects financed by the ETS proceeds:
Germany is the country receiving most proceeds from EU ETS auctions (between 2013 and 2020, it has received €13.1 billion). It uses them all for climate action across several projects. In 2020, the distribution of revenues was as follows:
The Innovation Fund is a programme to help the transition to lower-carbon technologies. Some of the EU ETS auction revenues that are not directly redistributed to Member states go to this initiative. The projects span across various sectors, including energy-intensive industries, renewables, energy storage, net-zero mobility, buildings, hydrogen, and carbon capture, use, and storage.
Some examples of projects financed by the Innovation Fund are:
The Modernisation Fund supports the modernisation of energy systems and the improvement of energy efficiency in 13 lower-income EU Member States. It was established in 2018 and aims to help the beneficiary Member States achieve their climate targets and the objectives of the European Green Deal. Just like the Innovation Fund, the Modernisation Fund is financed by revenues from the auctioning of emission allowances under the EU Emissions Trading System (EU ETS).
The beneficiary Member States are Bulgaria, Czechia, Estonia, Greece, Croatia, Latvia, Lithuania, Hungary, Poland, Portugal, Romania, Slovenia and Slovakia.
Some examples of projects financed by the innovation fund are:
From 2027 on, a new Emissions Trading Scheme will be out in place - the EU ETS II. It will cover emissions from building construction and road transportation. Some concerns have merged as to whether this new ETS will negatively impact lower income households unfairly. As a response, the EU has introduced the Social Climate Fund that will operate between 2026 and 2032. It will provide temporary direct income support to the ones affected. Also, the programme will provide funds for improving the energy efficiency of buildings and help uptake low-emission mobility.
Carbon markets are now accessible to any investor through Homaio’s EU ETS trading platform. By participating in the emission allowances market, you can contribute to the overall reduction of greenhouse gas emissions in the European Union. As seen above, the funds generated through the auctioning of EU Allowances (EUA) play a crucial role in supporting various climate projects and initiatives.
Sources
European Commission, 2023. Auctioning
European Commission, 2023. What is the EU ETS?
European Commission, 2023. Innovation Fund
European Commission, 2023. Modernisation Fund
Reuters, 2021. World needs $5 trillion in annual climate finance by 2030 for rapid action
EU Monitor, 2023. Explanatory Memorandum - EU Climate Action Progress Report 2023
Eco Logic, 2022. The use of auctioning revenues fromthe EU ETS for climate action
