The EU emissions trading system (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 ETS:

  • operates in all EU countries plus Iceland, Liechtenstein and Norway
  • limits emissions from more than 11,000 heavy energy-using installations (power stations & industrial plants) and airlines operating between these countries
  • covers around 45% of the EU’s greenhouse gas emissions.

A ‘cap and trade’ system

The EU ETS works on the ‘cap and trade’ principle.

A cap is set on the total amount of certain greenhouse gases that can be emitted by installations covered by the system. The cap is reduced over time so that total emissions fall.

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.

Trading brings flexibility that ensures emissions are cut where it costs least to do so. A robust carbon price also promotes investment in clean, low-carbon technologies.

Developing the carbon market

Set up in 2005, the EU ETS is the world’s first international emissions trading system.

The EU ETS is also inspiring the development of emissions trading in other countries and regions. The EU aims to link the EU ETS with other compatible systems.

Delivering emissions reductions

The EU ETS has proved that putting a price on carbon and trading in it can work. Emissions from installations in the system are falling as intended (see 2018 figures).

In 2020, emissions from sectors covered by the system will be 21% lower than in 2005. The EU is on track to surpass this target.

In 2030, emissions from sectors covered by the EU ETS will be cut by 43% from 2005 levels, as part of the EU’s current 2030 climate and energy framework.

Under the European Green Deal, the Commission will present an impact-assessed plan to increase the EU’s greenhouse gas emission reduction target in a responsible way, including for the EU ETS.

Sectors and gases covered

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

  • 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 and glyoxylic acids and glyoxal
  • perfluorocarbons (PFCs) from aluminium production

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

  • in some sectors only plants 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 31 December 2023 the EU ETS will apply only to flights between airports located in the European Economic Area (EEA).

Key features of phase 3 (2013-2020)

The EU ETS is now in its third phase, which is significantly different from phases 1 and 2.

The main changes from the previous two phases are:

  • A single, EU-wide cap on emissions applies in place of the previous system of national caps
  • Auctioning is the default method for allocating allowances (instead of free allocation), and harmonised allocation rules apply to the allowances still given away for free
  • More sectors and gases included
  • 300 million allowances set aside in the New Entrants Reserve to fund the deployment of innovative, renewable energy technologies and carbon capture and storage through the NER 300 programme

Key features of phase 4 (2021-2030)

The legislative framework of the EU ETS for its next trading period (phase 4) was revised in early 2018 to enable it to achieve the EU’s 2030 emission reduction targets and as part of the EU’s contribution to the Paris Agreement.

The revision focuses on:

  • Strengthening the EU ETS as an investment driver by increasing the pace of annual reductions in allowances to 2.2% as of 2021 and reinforcing the Market Stability Reserve (the mechanism established by the EU in 2015 to reduce the surplus of emission allowances in the carbon market and to improve the EU ETS’s resilience to future shocks)
  • Continuing the free allocation of allowances as a safeguard for the international competitiveness of industrial sectors at risk of carbon leakage, while ensuring that the rules for determining free allocation are focused and reflect technological progress
  • Helping industry and the power sector to meet the innovation and investment challenges of the low-carbon transition via several low-carbon funding mechanisms

EU ETS Handbook

For more information on the EU ETS, see the EU ETS HandbookSearch for available translations of the preceding link. Please note that the information contained in the handbook reflects the status quo at the time of its publication in 2015.