The EU Emissions Trading System (EU ETS)
The EU emissions trading system (EU ETS) is a cornerstone of the European Union’s policy to combat climate change and its key tool for reducing industrial greenhouse gas emissions cost-effectively. The first – and still by far the biggest – international system for trading greenhouse gas emission allowances, the EU ETS covers more than 11,000 power stations and industrial plants in 31 countries, as well as airlines.
A ‘cap and trade’ system
The EU ETS works on the ‘cap and trade’ principle. A ‘cap’, or limit, is set on the total amount of certain greenhouse gases that can be emitted by the factories, power plants and other installations in the system. The cap is reduced over time so that total emissions fall.
In 2020, emissions from sectors covered by the EU ETS will be 21% lower than in 2005. By 2030, the Commission proposes, they would be 43% lower.
Within the cap, companies receive or buy emission allowances which they can trade with one another as needed. They can also buy limited amounts of international credits from emission-saving projects around the world. The limit on the total number of allowances available ensures that they have a value.
After each year a company must surrender enough allowances to cover all its emissions, otherwise heavy fines are imposed. If a company reduces its emissions, it can keep the spare allowances to cover its future needs or else sell them to another company that is short of allowances. The flexibility that trading brings ensures that emissions are cut where it costs least to do so.
By putting a price on carbon and thereby giving a financial value to each tonne of emissions saved, the EU ETS has placed climate change on the agenda of company boards and their financial departments across Europe. A sufficiently high carbon price also promotes investment in clean, low-carbon technologies.
In allowing companies to buy international credits, the EU ETS also acts as a major driver of investment in clean technologies and low-carbon solutions, particularly in developing countries.
Phase 3 brings significant changes
Launched in 2005, the EU ETS is now in its third phase, running from 2013 to 2020. A major revision approved in 2009 in order to strengthen the system means the phase 3 is significantly different from phases 1 and 2 and is based on rules which are far more harmonised than before. The main changes are:
- A single, EU-wide cap on emissions applies in place of the previous system of national caps;
- Auctioning, not free allocation, is now the default method for allocating allowances. In 2013 more than 40% of allowances will be auctioned, and this share will rise progressively each year;
- For those allowances still given away for free, harmonised allocation rules apply which are based on ambitious EU-wide benchmarks of emissions performance;
- Some more sectors and gases are included;
- 300 million allowances set aside in the New Entrants Reserve to fund the deployment of innovative renewable energy technologies as well as carbon capture and storage through the NER 300 programme.
Almost half of EU emissions covered
Altogether the EU ETS covers around 45% of total greenhouse gas emissions from the 28 EU countries.
While emissions trading has the potential to cover many economic sectors and greenhouse gases, the focus of the EU ETS is on emissions which can be measured, reported and verified with a high level of accuracy.
The system covers emissions of carbon dioxide (CO2) from power plants, a wide range of energy-intensive industry sectors and commercial airlines. Nitrous oxide emissions from the production of certain acids and emissions of perfluorocarbons from aluminium production are also included (see box).
Participation in the EU ETS is mandatory for companies operating in these sectors, but in some sectors only plants above a certain size are included. Governments can exclude certain small installations from the system if fiscal or other measures are in place that will cut their emissions by an equivalent amount.
The EU ETS covers CO2 emissions from flights within and between countries participating in the EU ETS. International flights to and from non-ETS countries are also covered.
In October 2013 the International Civil Aviation Organization (ICAO) Assembly agreed to develop a global market-based mechanism to address international aviation emissions by 2016, and to apply it by 2020. In response, the EU has decided to limit the scope of the EU ETS to flights within Europe until 2016. Exemptions for operators with low emissions have also been introduced.
Making a difference
The EU ETS has put a price on carbon and shown that it is possible to trade in greenhouse gas emissions. Emissions from installations in the scheme are falling as intended.
Emissions of greenhouse gases from installations participating in the EU ETS are estimated to have decreased by at least 3% in 2013. For more information on the reductions in both ETS and non-ETS sectors, see the annual reports on progress made by the European Union and its Member States towards their greenhouse gas emission targets.
The success of the EU ETS has inspired other countries and regions to launch cap and trade schemes of their own. The EU aims to link up the ETS with compatible systems around the world to form the backbone of an expanded international carbon market.
Structural reform and 2030 framework
However, the ETS also faces a challenge in the form of a growing surplus of allowances, largely because of the economic crisis which has depressed emissions more than anticipated.
In the short term this surplus risks undermining the orderly functioning of the carbon market; in the longer term it could affect the ability of the EU ETS to meet more demanding emission reduction targets cost-effectively.
The Commission has therefore taken the initiative to postpone (or ‘back-load’) the auctioning of some allowances as an immediate first step.
In addition, following a public debate on options for structural reform of the carbon market which could provide a sustainable solution to the surplus in the longer term, a Market Stability Reserve shall be established in 2018 and the placing of allowances in the reserve shall operate from 1 January 2019.
As part of the agreement reached by the European Parliament and the Council, the 900 million backloaded allowances will be placed directly in the reserve. The remaining allowances that are unallocated by at the end of the current trading phase (2020) will also be placed in the reserve.
Efforts to address the market imbalance would also be helped by a faster reduction in the EU ETS cap. To achieve the target of a 40% reduction in EU greenhouse gas emissions below 1990 levels by 2030, set out in the 2030 framework for climate and energy policy, the cap will need to be lowered by 2.2% per year from 2021, compared with 1.74% currently.
EU ETS: Key facts
- Operates in the 28 EU countries and the three EEA-EFTA states (Iceland, Liechtenstein and Norway)
- Covers around 45% of the EU’s greenhouse gas emissions
- Limits emissions from:
- More than 11,000 heavy energy-using installations in power generation and manufacturing industry
- Aircraft operators performing aviation activities in the EU and EFTA states
Greenhouse gases and sectors included
- Carbon dioxide (CO2) from
- Power 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
- Nitrous oxide (N2O) from production of nitric, adipic, glyoxal and glyoxlic acids
- Perfluorocarbons (PFCs) from aluminium production
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