About
The EU ETS is part of the EU's strategy to combat climate change and a key tool for helping EU Member States in reducing greenhouse gas emissions in a cost-effective way.
The EU ETS works on the "cap and trade" principle:
- A maximum cap is set on the total amount of greenhouse gases that can be emitted by all entities covered by the system.
- Within that limit, entities are allowed to buy and sell a fixed amount of so-called "allowances" as they require. One allowance gives the holder the right to emit one tonne of CO2 or the equivalent amount of another greenhouse gas.
All operators carrying out an activity covered by the EU ETS must hold greenhouse gas emission permits. Entities covered by the EU ETS must monitor and report their emissions each year and surrender enough emission allowances to cover their annual emissions (for the previous year). Otherwise, fines or other penalties will be imposed. If a company reduces its emissions, it may keep the spare allowances to cover its future needs or it could sell them to another company that is short of allowances.
The cap is reduced over time so that the amount of emissions gradually decreases. As part of the 'Fit for 55 package' presented on 14 July 2021, the EU has revised EU ETS in line with the overall target of reducing greenhouse gas emissions by at least 55% by 2030, compared to 1990 levels. The ambition to cut carbon emissions covered by the EU ETS has been raised to 62% by 2030 (compared to 2005 levels). The annual reduction rate for the number of allowances in the system has been increased from 2.2% to 4.3%, and will eventually reach 4.4% annually. Free allowances to industry sectors will be phased out from 2026 and disappear by 2034 in connection with the implementation of CBAM. New requirements for full allocation of free allowances have been introduced, including requirements for energy efficiency as well as requirements for a climate neutrality plan for certain installations. Municipal waste incineration plants were included in the EU's emissions trading system starting in 2024, but will only be required to monitor and report their emissions for now.
Scope of the EU ETS for Installations
The EU ETS applies to installations carrying out activities listed in Annex I to the EU ETS Directive, covering a wide range of sectors and greenhouse gas emissions sources, including more than 10,000 installations in the power sector and energy intensive industry across the EU and EEA.
The principal categories of installations covered include:
- Combustion plants with a total rated thermal input exceeding 20 MW, excluding hazardous or municipal waste installations. Combustion installations form the largest category of installations in the EU ETS and include combined heat and power plants, district heating facilities, and industrial boilers
- Oil refineries
- Metal production and processing, including iron and steel, aluminium, and ferrous metals
- Mineral industry installations, such as cement, lime, glass, and ceramics production.
Chemical industry installations, including those producing bulk organic chemicals, ammonia, nitric acid, adipic acid, and glyoxal - Pulp and paper production
- Carbon capture and storage
In addition, a separate system related to combustion-related emissions from activities not covered by the current EU ETS was proposed, named ETS2. This new system will cover and address the CO2 emissions from fuel combustion in buildings, road transport and additional sectors, and will in all likelihood become fully operational in 2028.
Installations and Exemptions
For the purposes of the EU ETS, an "installation" is defined as a stationary technical unit where one or more activities listed in Annex I to the EU ETS Directive are carried out, as well as any other directly associated activities which have a technical connection with the activities carried out on the site and which could have an effect on emissions and pollution. Each installation must hold a valid greenhouse gas emission permit issued by the competent authority of the relevant Member State before commencing operations covered by the EU ETS. Certain installations are excluded or may benefit from simplified arrangements.
Procedure for Verifying Emissions
The EU ETS requires all operators of covered installations to monitor, report and verify their greenhouse gas emissions on an annual basis. Each installation must have an approved monitoring plan, setting out the methodology for monitoring and calculating emissions. The monitoring plan must be approved by the national competent authority and be kept up to date.
Each year, the installation's emissions are reported and an accredited verifier verifies the reported emissions. The annual compliance cycle is as follows: for emissions in each calendar year, operators must carry out monitoring procedures and prepare an emissions report. The verified emissions report must be submitted to the competent authority by 31 March of the following year. By 30 September of that same year, operators must surrender emission allowances equivalent to their verified emissions in the Union Registry.
The Responsible Party
The operator of the installation is the responsible party for compliance with the EU ETS. The operator is defined as any person who operates or controls an installation, or to whom decisive economic power over the technical functioning of the installation has been delegated.
Each installation is allocated to the competent authority of the Member State in which it is situated. The operator must hold a greenhouse gas emission permit and ensure that monitoring, reporting, verification and the timely surrender of allowances are carried out in accordance with the EU ETS Directive and its implementing regulations.
Allowances and Free Allocation
Operators of installations covered by the EU ETS must surrender allowances equivalent to their verified emissions each year. Allowances may be obtained through free allocation, auctioning, or purchase on the secondary market.
Free allowances to industry sectors will be phased out from 2026 and disappear by 2034 in connection with the implementation of CBAM. New requirements for full allocation of free allowances have been introduced, including requirements for energy efficiency as well as requirements for a climate neutrality plan for certain installations. The phase-out of free allocation is designed to work in tandem with the CBAM, which aims to prevent carbon leakage by imposing a carbon price on certain imports into the EU.
Sanctions and Enforcement
In case of non-compliance, operators are liable to pay an excess emissions penalty of EUR 100 (adjusted for inflation) per tonne of CO₂ equivalent for which no allowance has been surrendered on time. This penalty is in addition to the obligation to surrender the outstanding allowances. The names of operators that fail to surrender sufficient allowances may be published.
Member States are required to adopt effective, proportionate and dissuasive penalties for breaches of EU ETS legislation. Where an operator persistently fails to comply with the requirements of the EU ETS and other enforcement measures have failed to ensure compliance, the competent authority may take further action, including the withdrawal or suspension of the greenhouse gas emission permit.
Who does it impact?
- EU/EEA Member States.
- Entities covered by the EU ETS as well as entities in sectors that will be included in the EU ETS.
Status: In force
The EU ETS operates in all EU countries in addition to Iceland, Liechtenstein and Norway.
Being in operation since 2005, the EU ETS is the world's first international emissions trading system. It remains the biggest one, accounting for over three-quarters of international carbon trading. The regime is continuously evolving to adapt to observed trading and cover new sectors.
Relation to other initiatives and regulations
The most recent revisions of the EU ETS form a part of the EU Fit for 55 package. The EU ETS for installations interacts closely with several other key regulatory instruments, including the Carbon Border Adjustment Mechanism (CBAM) for imports of carbon-intensive goods, the ETS2 for buildings and road transport, and the EU ETS Innovation Fund, which supports decarbonisation technologies.
In 2012, the aviation sector was included into the EU ETS, however, only for intra-European flights. Read more about the EU ETS and aviation here. From 2024, a phase-in of the shipping industry has started. Read more about the EU ETS and the shipping industry here.
Participants
The EU ETS applies to the EU Member States as well as the three members of the European Economic Area, Norway, Iceland and Liechtenstein.
Thommessen's comments
Intending to create a financial incentive for participating emitters to cut their emissions, or alternatively pay others to do so, the EU ETS aims at providing flexibility in the carbon trading system ensuring that emissions are cut where it costs the least.
As part of the 'Fit for 55 package', the EU ETS was revised to align the scheme with the EU's objective of reducing emissions by 55% before 2030 and to achieve climate neutrality in the EU by 2050. Many of the provisions of the revised EU ETS came into force on 1 January 2024.
The revised EU ETS Directive brings new sectors into the system, including emissions from maritime transport, road transport and the building sectors. All companies in sectors with large emissions should have an understanding of the EU ETS, and be mindful of the newly revised extensions of the scheme, as well as the new obligations that must be complied with.
The work on the next major revision of the EU ETS Directive is underway. The goal is to strengthen the EU ETS and the Market Stability Reserve (MSR) to ensure cost-effective emission reductions in line with the target of climate neutrality by 2050. Several significant changes are being considered, including the inclusion of carbon removal and obligation to surrender allowances for municipal waste incineration plants. The revision is to be completed by the end of 2026. The EU's emissions trading system has significant implications for the sectors it covers. We therefore encourage stakeholders who are subject to or affected by the regulations, as well as those who risk being included, to keep track of the development.