European Union Energy Trading System (EU ETS)

Set up in 2005, the EU Emissions Trading System (EU ETS) is the world’s first and biggest international emissions trading system, accounting for over three-quarters of international carbon trading. The EU ETS is a cornerstone of the EU’s policy to combat climate change and its key tool for cost effective reduction in greenhouse gas (GHG) emissions.

The EU ETS works on the ‘cap and trade’ principle whereby 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 driving down emissions. Within the cap, companies receive or buy emission allowances which they can trade with other participants as necessary. There is also the opportunity to purchase a limited number of international credits from other emission-saving projects around the world. By limiting the total number of credits, the value is retained and GHG emissions are driven down due to lack of availability.

Each year a participant organisation must surrender enough allowances to cover all its emissions to avoid heavy fines. By reducing emissions, a company can retain spare allowances to cover future need or it can sell them to another company in need. By operating a trading mechanism, it ensures that emissions are cut across all participants but offers a safeguard to organisations that find reduction in energy use impossible or cost-prohibitive at any given time. Maintaining a robust carbon price also promotes investment in clean, low-carbon technologies.

The EU ETS is now in its third phase which differs significantly from the previous 2 phases. Phase 3 saw the introduction of a single, EU-wide cap on emissions applied in place of the previous system of individual national caps. To replace the previous method free allocation for distribution, an auction is now the default method for allocating allowances. There was also a expansion of the participant sectors and additional GHG gases were included. One of the major changes saw 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; one of the world’s largest funding programmes for innovative low-carbon energy projects.

The system covers the following sectors and gases with the focus 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 2016 the EU ETS applies only to flights between airports located in the European Economic Area (EEA).

The EU ETS has proved its success to date with emissions from installations in the scheme falling by around 5% compared to the beginning of phase three. It is anticipated that, in 2020, emissions from sectors covered by the system will be 21% lower than in 2005.

The UK has the opportunity to remain in the EU ETS after Brexit. The EU has an interest in allowing the UK to remain in the scheme as the supply and demand gap for the rest of the EU will be tighter without Britain which would mean balancing for other members would need to be closely managed.

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