Are carbon allowances permits to pollute?

European Union Allowances (EUAs) are not permits to pollute. The EU Emissions trading scheme (EU ETS) drives decarbonization by incentivizing all companies to go green, not by favoring the rich. 

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The cap of a cap-and-trade: an equal limit for all 

Every EUA represents 1 tonne of carbon dioxide. When an industry representative buys and surrenders an EUA to the European Commission, it withdraws 1 tonne from the overall carbon budget available for the entire economy, while releasing 1 tonne of carbon into the atmosphere for its operation. 

1 EUA surrendered = 1 tonne less in the total carbon budget = 1 tonne of CO2 released by a European industrial

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The cap of the EU ETS

In this framework, the cap represents a common limit for all EU ETS installations, regardless of size, sector, or any other characteristics. Each tonne of carbon emitted reduces the total budget and requires the surrendering of one EUA.

The cap-and-trade system creates economic incentives for companies to invest in greener technology and reduce emissions. The decreasing cap ensures that allowances become scarcer and more expensive, pushing companies to adopt more sustainable practices.

Carbon pricing is not a tax on carbon 

There is a misconception that a carbon allowance in a cap-and-trade system means you can “keep polluting if you have the money.” This confusion usually stems from confusing carbon allowances with carbon taxes. Unlike allowances, which set a cap on total emissions, carbon taxes are paid based on the amount of carbon released, allowing companies to “keep polluting as long as they pay the tax”.

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The misunderstood carbon terminology

Carbon Credits

Carbon credits, often used interchangeably with carbon offsets, represent reductions or removals of CO2. They are issued by initiatives that are often organized by projects, such as reforestation initiatives. These credits are traded in the voluntary market and are not subject to the same regulatory constraints as carbon allowances.

Carbon Quotas

“Quotas” is a more accurate term for carbon allowances. They describe the traded financial instrument that EUAs are, channeling the limited and decreasing common carbon budget available to the overall economy. 

Carbon Permits

The term "carbon permits" is a term often used to designate carbon allowances, yet the meaning that can be implied is false - EUAs do not permit anyone to release as much carbon they would like to, as long as they provide the corresponding economic funds. 

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Quotas, credits, taxes… The different approaches to price carbon 

Voluntary or mandatory? 

EUAs differ fundamentally from the credits issued within voluntary carbon markets. The EU ETS operates as a compliance regulation that is mandatory for all covered entities, setting a progressively decreasing cap on overall carbon emissions for the entire economy. 

On the other hand, voluntary carbon markets  function independently of government regulations and are often used by companies to meet internal carbon goals or address consumer demand for sustainable products and services. Credits in these markets are purchased voluntarily and can come from a nearly infinite range of projects and initiatives.

Infinite or limited emissions 

While both the EU ETS and carbon taxes are mandatory for installations, they differ in their structure. Unlike the EU ETS, which enforces a single, declining CO2 budget, a carbon tax allows for ongoing emissions as long as the polluter is willing and able to pay. In this sense, a carbon tax resembles voluntary carbon markets, where there is no fixed reduction target and compliance is more a matter of financial capacity rather than a predetermined emissions budget.

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EUAs are not permits to pollute. They enforce “the ETS polluter pays principle” and manage a common decreasing carbon budget to address CO2's negative externalities.

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