EU Emissions Trading System (EU ETS)

The EU ETS is a cornerstone of the EU's policy to combat climate change and its key tool for reducing greenhouse gas emissions cost-effectively. It is the world's first major carbon market and remains the biggest one.

The EU Emissions Trading System:

Operates in all EU countries plus Iceland, Liechtenstein and Norway (EEA-EFTA states),

limits emissions from around 10,000 installations in the energy sector and manufacturing industry, as well as aircraft operators operating between these countries,

covers around 40% of the EU's greenhouse gas emissions.

A 'cap and trade' system

Within the cap, operators buy or receive emissions allowances, which they can trade with one another as needed. The limit on the total number of allowances available ensures that they have a value. The price signal incentivises emission reductions and promotes investment in innovative, low-carbon technologies, whilst trading brings flexibility that ensures emissions are cut where it costs least to do so.

After each year, an operator must surrender enough allowances to cover fully its emissions, otherwise heavy fines are imposed. If an installation reduces its emissions, it can keep the spare allowances to cover its future needs or else sell them to another operator that is short of allowances.

Revenues from the sale of allowances in the EU ETS mostly feed into Member States’ budgets. Allowances are also auctioned to supply the funds supporting innovation in low-carbon technologies and the energy transition.

Sectors & gases covered

The EU ETS covers the following sectors and gases, focusing on emissions that can be measured, reported and verified with a high level of accuracy:

1. carbon dioxide (CO2) from:

• • electricity 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,
  • aviation within the European Economic Area.

1. nitrous oxide (N2O) from production of nitric, adipic and glyoxylic acids and glyoxal.
2. perfluorocarbons (PFCs) from the production of aluminium.

Participation in the EU ETS is mandatory for companies in these sectors, but:

• in some sectors, only operators above a certain size are included,
• certain small installations can be excluded if governments put in place fiscal or other measures that will cut their emissions by an equivalent amount,

in the aviation sector, until at least 31 December 2023 the EU ETS will apply only to flights between airports located in the European Economic Area. As of 1 January 2019, aircraft operators are required to monitor and report their emissions also for the European Economic Area.

The European Union Emission Trading System (EU ETS) is the cornerstone of the EU's policy to combat climate change and a key tool for reducing greenhouse gas emissions in a cost-effective way. It's the first and largest international system for the trading of greenhouse gas emission allowances, covering more than 11,000 power stations and industrial plants in 31 countries, as well as airlines.

Phase 4 of the EU ETS includes several key changes to the system's previous structures, such as:

• Market Stability Reserve (MSR): The MSR is a mechanism that was introduced in 2015 and came into operation in 2019 to address the surplus of emission allowances that had built up in the system and was suppressing the carbon price. The MSR automatically adjusts the supply of sold allowances to the market.
• Linear Reduction Factor (LRF): The LRF is the annual reduction in the cap on the maximum permitted emissions. For Phase 4, the LRF has been increased from 1.74% to 2.2% per year, in order to achieve a more significant reduction in greenhouse gas emissions.
• Free allocation and carbon leakage: Phase 4 introduces changes in the way free allowances are allocated. Industries at a significant risk of relocating their emissions outside the EU (carbon leakage) will receive a higher proportion of free allowances. The system for determining these industries will be more targeted and dynamic, with the list of sectors updated every 5 years.
• Innovation and Modernisation Funds: Two new funds will be set up using revenues from the auctioning of allowances. The Innovation Fund will support the demonstration of innovative technologies and the Modernisation Fund will facilitate investments in modernising the power sector and wider energy systems and boosting energy efficiency in 10 lower-income EU Member States.

Ahmed Sakr

Product Compliance Consultant 

ComplyMarket UG (haftungsbeschraenkt)