The EU Emissions Trading System (EU ETS) scheme
The EU Emissions Trading System (EU ETS) is a crucial tool used by the European Union to combat climate change. The EU ETS is a “cap and trade” system that allows trading of emission allowances, which helps to reduce emissions in a cost-effective and economically efficient manner. The system was first introduced in 2005 and has undergone several changes since then.
The EU ETS works by placing a cap on the total amount of emissions allowed within a specified period. Within this cap, installations (factories, power plants, etc.) are required to buy or receive emissions allowances, which they can trade with one another as needed. The limit on the total number of allowances available ensures that they have a value. At the end of each year, an installation must surrender enough allowances to cover its emissions fully. If an installation reduces its emissions, it can keep the spare allowances to cover its future needs or else sell them to another installation that is short of allowances.
The EU ETS compliance cycle requires operators of industrial installations and aircraft operators to monitor and report their annual emissions to their Competent Authority (CA). This procedure can be summarised in an annual compliance cycle.
The EU ETS has undergone several phases since its introduction. In Phase 1, individual countries defined the cap, and the sum of it became the EU CAP. This initial phase was able to establish a price for EUAs, free trade throughout the EU, and the infrastructure for monitoring, reporting and verifying actual emissions from the covered installations. Approximately 200 million tonnes of CO2 or 3% of total verified emissions were reduced due to the ETS at nominal transaction costs.
In Phase 2, aviation was included as a sector, and the scope was amended to include nitrous oxide from nitric acid production from several Member States. Businesses were allowed to use credits from the Kyoto Protocol’s Clean Development Mechanism (CDM) and Joint Implementation (JI) leading to a total of 1.4 billion tons of CO2 equivalent credits on the market (with the exception of those for nuclear facilities, agricultural and forestry activities).
In Phase 3, the EU defined the overall cap, and it is then allocated to countries. A linear reduction of 1.74% annually on overall emission allowance at the EU level was included, as well as the concept of auction and free reserve. Carbon leakage safeguards were included to prevent production transfer to countries with laxer climate policies.
The EU ETS has proven to be an effective tool in reducing greenhouse gas emissions. In the 15 years since its introduction, the system has become the cornerstone of the EU’s efforts to reduce greenhouse gas emissions. The system has also been an inspiration for other countries to develop similar systems, making it a leading example of how carbon markets can work in practice.