Content updated 9 March 2023

EU Emissions Trading System (EU ETS)

In December 2022, an agreement on the reform of the Emissions Trading Scheme (EU ETS) was reached between the European Council and the European Parliament. The deal is pending formal adoption by both institutions and the full text is still awaited.

The legislative framework of the European carbon market is spelled out in the ETS Directive, which has been revised several times to maintain the system’s alignment with the EU climate policy objectives.

It is the second-largest carbon market in the world (behind China) and covers around 40% of the EU's greenhouse gas emissions and operates in all EU countries, plus Iceland, Liechtenstein and Norway (EEA-EFTA states).

The system limits GHG emissions from around 10,000 installations (defined in article 3 of the Directive) in the power sector and manufacturing industry, as well as airlines operating between these countries.

Under the European Green Deal, in September 2020 the Commission presented an impact-assessed plan to increase the EU’s net GHG emissions reductions target to at least 55% by 2030. The Fit for 55 package proposes to revise several pieces of EU climate legislation, including the EU ETS.

Revisions of the ETS system include:

  • Free allowances under the EU ETS will diminish over a nine-year period between 2026 and 2034. EU producers will then pay their full domestic carbon costs.The allowances need to be phased out as the CBAM is phased in (link to eceee page on CBAM).
  • A separate emissions trading market for domestic and commercial buildings and transport (ETS2) will be created, which will launch in 2027.
  • The price on aviation carbon emissions will continue to apply only to flights within Europe.
  • Flights travelling to or from outside of the EEA will be covered by the United Nation’s CORSIA, with a substantially lower price on emissions than the EU’s Emission Trading System (ETS).
  • The European Commission must assess by 1 July 2026 whether the CORSIA system is an effective tool to cut global flight emissions. If not, the ETS will apply to all flights departing from an airport located in the EEA. Flights to countries not applying CORSIA will also fall under the scope of the ETS from 2027.
  • To help support low-income homes, the EU will use proceeds from the ETS2 to create a new €87bn ‘Social Climate Fund’. It has also set a ceiling carbon price of €45 per tonne.
  • Sectors covered by the ETS will have to cut their emissions 62% below 2005 levels by 2030 – a significant increase on the current 43% target. Free allowances will be halved by 2030 and then phased out entirely by 2034.
  • A sustainable aviation fuel (SAF) allowance scheme has also been agreed, which will allow airlines to deduct the cost of green jet fuels from their ETS bill. Some 20 million allowances have been reserved between 2024 and the end of 2030 to cover airlines that ramp up their use of SAFs.
  • There will be a gradual introduction of obligations for shipping companies to surrender allowances: 40% for verified emissions from 2024, 70% from 2025, and 100% from 2026.
  • The regulation will also require methane emissions from EU energy imports to be tracked (which is significant, given that EU imports 97% of its oil and 90% of its natural gas).

Flight emissions

There have been arguments that for far too long there have been free certificates for air travel, while rail customers have long been paying the ETS price, the rail system being mainly powered by electricity.

A legal proposal will be presented in 2028 to extend the scope of the EU ETS to cover all flight emissions. Long-haul flights make up some 6% of flights departing from the EEA but are responsible for around half of all CO2 and NOx emissions.

A ‘cap and trade’ system

The EU ETS works on the ‘cap and trade’ principle. A cap, which is reduced over time, is set on the total amount of certain greenhouse gases that can be emitted by the installations covered by the system.

The system operates in trading phases and enters now into its fourth trading phase (2021–2030). The framework for phase 4 was revised in 2018 to ensure emissions reductions in support of the EU's 2030 emissions reduction target and as part of the EU’s contribution to the Paris Agreement.

Within the cap, installations buy or receive emissions allowances, which they can trade with one another as needed. If the allowances of an installation do not fully cover its emissions, heavy fines are imposed. If it reduces its emissions, it can keep the spare allowances to cover its future needs or else sell them to another installation.