What are the main characteristics of the EU ETS?
Summary
The EU Emissions Trading System (ETS) is a cornerstone of European green finance and climate policies, using a carbon market to reduce greenhouse gas emissions from key sectors. It has evolved through phases, expanded its scope (including aviation and maritime), and contributed to a significant reduction in emissions, and revisions are coming to make the EU ETS even more effective for decarbonization as Europe pursues carbon neutrality by 2050. The EU ETS allows companies to buy carbon allowances, incentivizing them to lower their emissions.
Since its inception in 2005, the European Union Emissions Trading System (EU ETS) has been a cornerstone of European climate policies.The EU ETS is both a financial mechanism and a regulatory framework to achieve the bloc’s ambitious environmental goals.
What is the EU ETS?
The EU ETS is a market-based approach to constraining and controlling the volumes of greenhouse gas emissions in the economy until carbon neutrality is achieved by 2050. As a cap-and-trade system, it sets a limit (or cap) on the total amount of greenhouse gases that can be emitted by installations covered by the system. To comply with this cap, companies are required to buy and surender carbon allowances, which represent the right to emit one tonne of CO2 each. Every tonne of carbon released is matched to one carbon quota.
The carbon marketplace
Carbon Allowances (EUAs): EUAs are the tradable financial assets within the EU ETS. Each EUA represents the right to emit one tonne of CO2. There are 2 markets within the scheme. The primary market where EUAs are initially issued by regulators through auctions or allocation processes; and the secondary market, where participants trade these allowances among themselves.
The EU ETS coverage
Initially, the EU ETS covered the industrial sector and power producers. By 2012, the aviation sector was included, and from 2024, the maritime sector was also integrated into the scheme.
The proven decarbonization impact
The EU carbon trading scheme covers around 40% of the EU’s total emissions. Over the past decade, it has contributed to a 35% reduction in emissions from covered sectors. In 2023 alone, CO2 emissions of covered installations were lowered by more than 16%.
A long journey towards sustainability
The phases of the EU ETS
The EU ETS has evolved through various phases, with different reforms aimed at improving its effectiveness and alignment with increasing climate ambitions:
- Phase 1 (2005-2007): The initial introductory phase, “setting the rules of the game”, where most allowances were given away for free.
- Phase 2 (2008-2012): International offsets were allowed to be used for EU ETS compliance. This, combined with the still high volumes of free EUAs and the impact of the global financial crisis, kept carbon prices low.
- Phase 3 (2013-2020): Phase 3 brought about important reforms to address supply-demand imbalances.
- Phase 4 (2021-2030): The current phase features an accelerated cap reduction and extends the system’s scope to include new sectors and mechanisms.
Improving the scheme’s effectiveness, one reform at a time
Over the years, the scheme has undergone several revisions that have:
- Balanced the Market, notably with the introduction of the Market Stability Reserve (MSR).
- Increased Ambition, through the phase-out of free allowances and the increased pace of supply reduction.
- Expanded Scope with the inclusion of the maritime sector in 2024, for instance.
- Strengthened International Influence, especially with the introduction of the Carbon Border Adjustment Mechanism (CBAM) in 2023 showing a commitment to global climate leadership.
The EU ETS is here to stay
Achieving Europe’s climate neutrality goal by 2050 remains an ongoing mission, and there is still some work to do. Despite the progress made so far, there are still some revisions to come that will make the EU ETS even more effective for decarbonization. The building and road transportation sectors will also soon be covered by a carbon pricing scheme. Also, the pace of cap reduction will increase to 4.4% per year starting in 2028, intensifying efforts to meet more ambitious climate targets sooner.
The EU ETS has come a long way, but the most exciting part of the decarbonization journey is yet to come.
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