European Union: The World’s First Large-Scale ETS Carbon Market

The EU Emissions Trading System (ETS) was launched in 2005 and was the world’s first international emissions trading system. It operates throughout all EU Member States, Norway, Iceland, and Liechtenstein, and has been broken into phases that include increasingly more restrictive carbon policies. The EU ETS is currently in phase 4, which spans from 2021 to 2030.

The EU ETS is based on a cap and trade system in which a limit is set on the total amount of greenhouse gases emitted by the energy installations and aircraft operators covered by the system. The cap system is based on the principle that each company’s carbon allowance gives it the right to emit one tonne of carbon dioxide equivalent. Companies must surrender enough allowances every year to account for their emissions. Companies are given some allowances at no cost, but most of a company’s allowances are required to buy from the EU carbon market or trade with one another. Companies can either keep their spare allowances or use them in a future year. Each year, the total cap amount decreases. The majority of the money that the EU receives from ETS allowance sales is funneled back into the national budgets of Member States. It supports investments in renewable energy, low-carbon technology development, and energy efficiency improvements. The money not funneled back into the Member States’ national budgets is channeled into the EU’s Innovation Fund and Modernization Fund.

The EU ETS regulates carbon dioxide emissions from electricity and heat generation, energy-intensive industry sectors such as oil refineries and steel works, aviation, and, as of the beginning of 2024, the maritime sector. It also regulates nitrous oxide from producing nitric, adipic, and glycolic acids and glyoxal and perfluorocarbons released from aluminum production.

The European Commission is responsible for annual monitoring, reporting, and verifying the EU ETS data it receives from its Member States. Each year, the European Commission undergoes the ETS compliance cycle, during which operators of installations that fall under the aforementioned sectors must submit an emissions report. Generally, the data provided by each installation must be verified by an accredited verifier by March 31 each year, and operators must hand over the equivalent number of allowances by April 30 each year. This year, an exception has been made in which operators have until September 30 to pay their allowances to give operators more time to compile data and purchase allowances. For each tonne of emissions that an operator does not provide an allowance for by the date allowances are due, there is a cost of EUR 100 that the operator must pay in addition to the allowance the operator must obtain and surrender. The names of penalized operators are also released to the public.  To facilitate a smooth monitoring and reporting process and assist operators, the European Commission has online templates that guide operators in creating monitoring plans, annual emission reports, verification reports, and improvement reports.

Since it was first employed in 2005, the EU ETS has brought down emissions from power and industry plants by 37.3% when compared to 2005 levels. The EU ETS also goes through frequent revisions to increase its effectiveness, with the last revision being a part of the EU’s “Fit for 55” package that the European Parliament adopted on April 18, 2023, and the European Council on April 25, 2023. The “Fit for 55” reform outlined the following goals in relation to the EU ETS:

  1. Reducing emissions in the EU ETS sector by 62% by 2030;
  2. Revising parameters for the Market Stability Reserve (MSR), which currently addresses differences in supply and demand that are often spurred by external shocks by transferring allowances from the auction volume to the reserves whenever the total number of allowances in circulation is more significant than 833 million;
  3. Expanding the EU ETS to cover the maritime shipping sector;
  4. A new and separate ETS (ETS2) is being created that will deal with emissions from sectors like buildings and road transport;
  5. Phasing out free allowances in some sectors in conjunction with the phasing-in of the Carbon Border Adjustment Mechanism (CBAM), will assist with decreasing carbon leakage and will ultimately phase out the free allowances that are in circulation throughout 2026 to 2034;
  6. A strengthened commitment to using ETS revenues to address distributional effects and spur innovation by funneling the revenues from ETS2 into the recently established Social Climate Fund, which aims to lessen the financial burden of more stringent ETS policies on the small businesses and citizens who are most significantly impacted by carbon price rises.

While the EU ETS has been effective in decreasing overall carbon emissions, and the effectiveness of the EU ETS should continue to increase given the new policies that were implemented at the beginning of this year, the EU ETS has been the subject of various criticisms over the years. One of the primary criticisms has been that the EU ETS only covers a portion of the EU’s total emissions; currently, only 40% of the EU’s total emissions are covered by the EU ETS. This is especially problematic when considering sectors like transport. The transport sector currently makes up about 25% of the EU’s total emissions, and road transport, which the EU ETS does not cover, comprises approximately 76% of the EU’s total transport emissions. Additionally, the EU ETS’ free allocation of allowances has been criticized, as critics argue that installation operators have little incentive to decrease their carbon emissions if provided with a certain number of free allowances each year. However, the market-based nature of the EU ETS can work to incentivize operators to decrease their emissions, as operators can make a profit off of allowances they sell to other operators.

While imperfect, the EU ETS is a market-based solid ETS model. It demonstrates that it is possible to implement a system that consistently decreases greenhouse gas emissions at both a national and international scale.

This Post was submitted by Climate Scorecard EU Manager Brittany Demogenes.

Learn More Resources:,ensuring%20that%20emissions%20decrease%20overtime



Climate Scorecard depends on support from people like you.

We are a team of researchers providing information on efforts to reduce global emissions. We help make you better informed and able to advocate for improved climate change efforts. Donations of any amount are welcome.