The EU Emissions Trading Scheme (ETS) is a fundamental component of the European Union’s strategy to combat climate change, serving as its primary means to cost-effectively reduce greenhouse gas emissions. It is not only the world’s pioneering carbon market but also the largest.
How Does the EU Emissions Trading Scheme (ETS) Work?
Operating on the cap and trade principle, the EU ETS sets a limit on the total permissible emissions of specific greenhouse gases from covered operators. This cap progressively decreases to drive down overall emissions.
Under this cap, operators can either purchase or allocate emissions allowances, which they can freely trade among themselves. The finite number of available allowances guarantees their intrinsic value. The price signal encourages emissions reduction efforts and encourages investment in innovative, low-carbon technologies. Simultaneously, trading provides flexibility to ensure emissions are minimized where it is most economically feasible.
At the end of each year, operators must surrender sufficient allowances to cover their emissions entirely; otherwise, they face substantial fines. Operators that reduce their emissions can retain surplus allowances for future use or sell them to operators in need.
Proceeds from allowance sales in the EU ETS primarily contribute to the budgets of Member States. Additionally, allowances are auctioned to provide funding for the advancement of low-carbon technologies and the energy transition through the Innovation Fund and the Modernisation Fund.
Which Sectors and Gases Does the EU Emissions Trading Scheme (ETS) Cover?
The EU ETS encompasses various sectors and gases, primarily focusing on emissions that can be accurately measured, reported, and verified. These sectors include carbon dioxide (CO2) emissions from electricity generation, energy-intensive industries such as oil refineries, steel production, and the manufacturing of various materials. It also includes aviation within the European Economic Area, maritime transport, nitrous oxide (N2O) emissions from specific chemical production processes, and perfluorocarbons (PFCs) from aluminum production.
Participation in the EU ETS is mandatory for companies in these sectors, with certain size thresholds and exemptions in specific cases, such as small installations with emissions reduction measures and limitations on aviation emissions until at least December 31, 2026.
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