Are you familiar with the EU’s Emissions Trading System? If you are not, don’t worry – we’ve got you covered. Our handy ETS 101 guide walks you through the EU ETS, its goals, how it functions, the challenges it faces and how to solve them.
Often referred to as a cornerstone of European Union climate policy, the EU’s Emissions Trading System (EU ETS) covers around 40% of all greenhouse gas (GHG) emissions in the EU. Although it has had its fair share of failures, the EU ETS is becoming a more effective climate tool each time it is reformed. Its current revision seeks to bring the EU ETS in line with the European Green Deal target of reducing emissions in the European Union by 55% by 2030 (compared to 1990). This will set the pace and scope of the EU ETS for the 2020s, a make-or-break decade for humanity to reign in its GHG emissions.
Launched in 2005, the EU ETS is the oldest emissions trading scheme in the world and the largest until 2021 when the Chinese ETS kicked off. It is a regulatory market created by policymakers to combat global heating and reduce GHG emissions by pricing greenhouse gas pollution from the power, industrial and aviation sectors. The EU ETS currently covers over 10,400 industrial plants and power stations, as well as approximately 350 airlines, across the 27 EU member states, Iceland, Norway and Liechtenstein.
If the cap fits
Based on the ‘polluter pays’ principle, the EU ETS sets an overall limit (a ‘cap’) on the total volume of greenhouse gas emissions. The cap is divided into millions of individual pollution permits. The reduction targets are achieved through the gradual lowering of this cap, which decreases yearly by a fixed proportion. The quicker the cap is reduced, the greater the climate ambition and the faster emissions fall.
Historically, the EU ETS has suffered from credibility issues due to low prices and an oversupply of pollution permits in the market. These low prices undermined the core objective of the EU ETS: driving down emissions. However, confidence in the EU ETS has been surging since the most chronic oversupply issues started to be addressed in 2018, leading to more accurate and fairer carbon prices. Nevertheless, these supply issues have only partially been resolved, with the oversupply standing at about 1.6 billion pollution permits in 2020.
In addition, the total reduction in emissions camouflages major differences between sectors. Utilities (electricity and heating) are the key reason why EU ETS emissions have decreased over time. However, industrial emissions have been more or less stagnant since 2013 while aviation emissions have increased (with the notable exception of 2020 when the COVID-19 pandemic resulted in a temporary drop for aviation and industry).
Ensuring a brighter future
The EU ETS and its current revision bring numerous challenges and opportunities. For instance, the European Commission proposed in 2021 to establish a separate ETS system for buildings and transport. At the same time, the EU ETS is providing an example and lessons learned for other countries seeking to implement a cap-and-trade mechanism. The Korean ETS and the Chinese ETS, for example, have taken some of these lessons on board, although they are also repeating some of the mistakes.
EU ETS: Challenges and solutions
|Bring the EU ETS in line with the Paris Agreement in a way that ensures that the EU bears its fair share of climate action to keep global warming below the crucial 1.5°C threshold
|Reduce the emissions cap to align it with real emission levels and permanently removing unnecessary surplus emission allowances from the market
|Europe’s industrial polluters made €50 billion in carbon market windfall profits between 2008 and 2019 (link). Under current legislation, the EU ETS would hand out up to 6.5 billion additional free emission allowances with a market value of about €325 billion in this decade.
|Abolish free allocation of pollution permits
|The EU ETS has accumulated a large and unsustainable oversupply before the mechanism to solve it, the Market Stability Reserve (MSR), became operational. Current national coal phase-out plans could add another 2 billion pollution permits to the oversupply within this decade.
|Strengthen the Market Stability Reserve so it can also deal with future sources of oversupply
|The EU ETS has a co-benefit of generating significant revenues through the auctioning of pollution permits. These revenues are a huge opportunity to finance climate action and support people through the climate transition
|Invest all revenues generated through the EU ETS into funding climate action and the fair transition to a climate-neutral Europe.
For more information, read our full ‘EU ETS 101‘ guide