The EU Emissions Trading System (EU ETS) is a cornerstone of the EU's climate policy, operating on a "cap-and-trade" principle to reduce industrial greenhouse gas emissions. It works by setting a strict limit (the cap) on emissions and creating a market for companies to trade emission allowances, effectively putting a price on carbon.
The EU Emissions Trading System (EU ETS) is the world’s first and largest market for carbon dioxide (CO₂) emissions. Launched in 2005, it is a mandatory scheme designed to be the primary driver of decarbonization in the European Union's energy and industrial sectors. Its core purpose is to make emitting CO₂ costly, thereby creating a powerful financial incentive for companies to invest in cleaner technologies and reduce their carbon footprint in a cost-effective way. The system currently covers over 10,000 power stations and manufacturing plants, as well as aviation within Europe.
The mechanism operates through a principle known as "cap-and-trade." This system is built on three key pillars:
- The Cap: The EU sets an overall limit, or "cap," on the total amount of greenhouse gases that can be emitted by all participating installations. This cap is gradually reduced over time to ensure that total emissions fall in line with the EU's climate targets.
- The Allowances (EUAs): The cap is divided into tradable emission allowances, where one allowance gives the holder the right to emit one tonne of CO₂ equivalent. A portion of these allowances is allocated to companies for free, while an increasing majority is sold at auction.
- The Trade: Companies that can reduce their emissions at a low cost can sell their surplus allowances on the market. Conversely, companies facing higher abatement costs must buy additional allowances to cover their emissions. This trading creates a flexible, market-based
carbon priceand ensures that emissions are reduced where it is most economical to do so.
Concrete Examples
- Incentivizing Green Investment: A European steel manufacturer invests in a new, energy-efficient production process. As a result, it emits 50,000 tonnes of CO₂ less than its allowance allocation for the year. The company can then sell these 50,000 surplus allowances on the EU ETS market, generating revenue that helps offset the cost of its technological upgrade.
- Compliance for High Emitters: An aging coal-fired power plant exceeds its emission limit due to high demand. To comply with the EU ETS regulation and avoid heavy fines, the plant operator must purchase the required number of additional allowances from the market, increasing its operational costs and reinforcing the business case for transitioning to cleaner energy sources.
This system is central to the climate finance landscape, turning carbon emissions into a regulated financial asset. Learn more about the European Union Allowances (EUAs) traded on this market and how they function as an investment. For official details, refer to the European Commission's page on the EU ETS.