Reducing man-made greenhouse gas emissions can help to limit global warming. The EU emissions trading system (EU ETS) is an essential part of the EU’s policy to combat climate change. The EU ETS is a “cap and trade” scheme where a limit (the cap) is placed on the right to emit specified pollutants over a geographic area and companies can trade emission rights within that area. It is the key tool for reducing greenhouse gas emissions, such as carbon dioxide (CO2), from electricity generation and industry. The EU ETS makes investing in environmentally friendly technology economically beneficial for industry and airlines.
The EU ETS:
The European Commission webpages give detailed information on the EU ETS.
The EU ETS works on the 'cap and trade' principle. This means that greenhouse gas allowances are treated as a commodity or product that can be traded on the EU carbon market. Companies that are regulated by the EU ETS include stationary installations (such as power plants, industrial plants and other large energy users) and airlines.
The overall volume of greenhouse gases that can be emitted by all the companies covered by the ETS is subject to a cap (or limit), which is set at EU level. The EU also decides how much and how quickly the total emissions should decrease. The cap or limit moves downwards each year to meet this emissions reduction target.
Companies regulated by the EU ETS must acquire carbon allowances. They can buy these on the carbon market or through the EU ETS auctions. Some companies regulated by the EU ETS receive a certain amount of allowances for free.
These carbon allowances only exist electronically. The companies regulated by the EU ETS must open Union Registry accounts to hold these carbon allowances. The Union Registry is like an online banking system which holds carbon allowances instead of money.
Every year, the companies regulated by the EU ETS must surrender enough carbon allowances out of their Union Registry accounts to account for their greenhouse gas emissions. So, like paying a bill with money, these companies account for their emissions using carbon allowances.
If these companies do not comply, heavy penalties are imposed.
If a company reduces its emissions, this reduces the amount of carbon allowances the company must surrender every year. The company can then keep the spare carbon allowances for use in the future. Alternatively, it can sell the spare carbon allowances to another company that is short of allowances.
When companies trade like this, it creates a market price for the carbon allowances. As the limit or cap decreases each year, the market price increases.
This ‘cap and trade’ approach makes it more economically attractive for companies to invest in emissions reduction technologies – and thus to reduce their greenhouse gas emissions.