EUAs, the permits within a Cap and Trade system
The EU Exchange Trading System is a cap and trade scheme. The European Commission decides on the maximal amount of carbon that can be emitted over a certain period of time. This is translated into a union-wide carbon budget.
Permits called European Carbon Allowances (EUAs) are issued to match the overall carbon budget. Every EUA corresponds to 1 ton of carbon dioxide. In 2023, approximately 1.5 billion EUAs will be issued.
How is the cap decided?
The EU ETS is a policy tool with precise environmental targets. The market design starts by considering the desired CO2 levels goals for a certain point in time. From there, they decide on the carbon budget for every year until then.
The European Economy should emit no CO2 by 2050. It should have reduced emissions by at least 55% by 2030 compared to the 1990 levels.
The end goal is to have a zero carbon economy but the emissions decrease should be gradual by then. So, every year, the European-wide CO2 budget is diminished. Every year, the European Commission issues fewer EUAs than the year before.
How is the trade organized?
Companies can receive carbon permits from the primary market. This means that they either receive them for free or buy them from the European Commission. The European Commission auctions one part of the carbon permits. After deciding on the yearly amount to be released, they also decide on the quantities to be issued every day. The level is not predetermined by authorities. 57% of allowances are auctioned. The remainder of the primary market EUAs is given out for free. With time, the European Commission aims at making the purchasing of EUAs increasingly costly. Free allowances will fade out by 2030 for almost all industries.
Companies needing to match their carbon emissions to permits can participate in the auctions in order to buy EUAs. Other players are allowed to take part in it too. Investment funds or other institutions take part in auctions with speculative objectives. Their objective is to generate returns by participating in the carbon allowance market.
Actors can also purchase EUAs from the secondary market. In this case, they would obtain them from other companies or funds that have already bought the EUAs from the European Commission.
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9. The price drivers
Multiple factors such as the weather, energy prices, or industrial activity can affect EUA prices.
8. The Legislative Frameworks
The EU ETS is rooted in a legislative framework dating back to the early 1990s.