What is the EU Emissions Trading System?

The EU Emissions Trading System explained

What is emissions trading?

The EU Emissions Trading System (EU-ETS) is the climate protection tool of the European Union. Within this system, European companies that emit large amounts of CO₂ have to buy emission rights. All major CO₂ emitters in the EU, e.g. coal-fired power plants, must participate.

These emission rights allow companies to emit a certain amount of greenhouse gases. If the allowed amount of CO₂ emissions is exceeded, companies have to buy additional emission rights. For each tonne of CO₂ that an industrial company wants to emit, it needs one emission right. Emission rights need to be submitted every year. If a CO₂ emitter fails to do this, heavy penalties are imposed and the rights will have to be submitted retrospectively.

Every year, the EU releases emission rights. And every year, it reduces the total number of these rights available. This mechanism is known as the “cap-and-trade”. As companies can buy fewer emission rights each year, the system allows the economy to emit less CO₂ each year. In doing so, an economic incentive is created to reduce CO₂ emissions. Emissions trading is used as part of a larger European climate policy strategy to combat climate change.

Emissions trading made simple

The Emissions Trading System works like this: The government sets a cap on CO₂ emissions that companies are allowed to emit in the EU.

Then, the EU creates emission rights. As these rights are limited in number, they restrict the amount of permitted CO₂ emissions. All participants in the EU have to buy from this set number of emission rights.

Companies that emit less CO₂ than their allocated allowance can sell their surplus emission rights. If, however, a company emits more CO₂ than the allowance they have been allocated, they must buy additional rights. This creates a financial incentive to emit less CO₂.

How emissions trading works

The Emissions Trading System operates at European level. Participants in the trade, for example companies from the energy or shipping industries, must hold a certain number of emission rights each year to legally cover their CO₂ emissions. Surplus rights can be sold, lacking rights have to be purchased. This is supposed to reduce CO₂ emissions and trigger a green transformation.

Since when do we have the EU Emissions Trading System?

The Emissions Trading System started in 2005 with a pilot phase lasting until 2007. Today, rights from the pilot phase are no longer in use.

What are the goals of the EU Emissions Trading System?

Goal of climate protection

The primary goal of emissions trading is to protect the climate. Through the trade of emission rights, companies are motivated to reduce their CO₂ emissions and contribute to climate protection.

Emissions trading goals

Emissions trading is a market-based instrument that enables companies to reduce their CO₂ emissions in a cost-effective way. It creates a cost for CO₂ emissions that motivates companies to reduce their emissions and to develop and use alternative, more climate-friendly technologies.

The goal of emissions trading is to achieve a significant reduction in CO₂ emissions and contribute to climate protection.

Which sectors must participate in the EU Emissions Trading System?

Who has to buy CO₂ rights?

EU based companies in certain sectors have to buy CO₂ emission rights if they are emitting greenhouse gases. These sectors include those producing steel and cement, electricity, coal power and gas, as well as intra-European aviation (take-off and landing within the EU). Shipping is now also included, the building and transport sectors are in the planning stage, but agriculture is not yet part of the European Trading System.

Who is allowed to trade in CO₂ rights?

All companies that take part in the European Trading System are allowed to buy and sell CO₂ emission rights to cover their emissions or sell off their surplus. We at ForTomorrow also buy EU emission rights.

The plan always was for the EU-ETS to be used for climate protection.

CO₂ rights and money

Who gets the money for selling CO₂ emission rights?

Companies emitting fewer greenhouse gases than they are allowed to, can sell their surplus rights and thus make money.

What happens to the money from emissions trading?

All revenues from the EU Emissions Trading System (ETS) and the national Emissions Trading Scheme (nEHS) go into the Energy and Climate Fund (EKF). This fund supports climate protection measures, including renewable energies, energy efficiency investments, national and international climate protection projects, electromobility and the expansion of the National Action Plan for Energy Efficiency (NAPE).

Price development of CO₂ emission rights in 2022

In 2022, the prices for CO₂ emission rights have stabilised and risen slightly due to increased demand. The price for an EU emission right is currently around 90 euros.

Emissions trading vs. CO₂ tax

What are the differences between emissions trading and CO₂ tax?

Emissions trading and the CO₂ tax differ in their implementation and objectives. While emissions trading entitles companies to buy and sell CO₂ rights, the CO₂ tax applies directly to the consumption of CO₂.

The disadvantage of using a tax is that if companies can afford it, they simply emit as much CO₂ as before. Since emission rights are limited, emissions trading does not allow for this. If the price of an emission right is high, a company concerned cannot emit any more CO₂.

Advantages of emissions trading

The advantages of emissions trading lie in its market-based approach with incentives for companies to reduce their emissions. The CO₂ tax, on the other hand, offers simpler regulation and a direct financial burden based on the amount of CO₂ emitted. To put it simply, both systems have their own advantages and disadvantages, and which system is best suited for a particular country will depend on various factors.

Emissions trading for private individuals

Can private individuals buy emission rights?

No, private individuals are not allowed to buy or sell CO₂ rights. Emissions trading is a system for companies in the EU.

Can I use the Emissions Trading System to protect the climate through ForTomorrow?

Yes, if you support ForTomorrow in buying emission rights, you as a private person can reduce the CO₂ emissions of the entire European Union.

Criticism of emissions trading

Issues with the Emissions Trading System

One issue with emissions trading was that a potential oversupply of emission rights could lead to price drops. The Market Stability Reserve was created to address this problem. If there are too many emission rights in circulation, the EU can transfer emission rights to the reserve or even delete rights to maintain price stability.

Emissions trading - sensible or not?

Where emissions trading has been implemented, CO₂ emissions have fallen. Where it has not, they have actually risen. Since the introduction of the European Emissions Trading System (ETS) in 2005, CO₂ emissions in the sectors covered by the ETS have fallen by almost 30 percent. This is a decrease well above the EU-wide target of 21 percent.

Emissions trading worldwide

Emissions trading in Germany

The EU Emissions Trading System (EU-ETS) is an important part of the European climate protection strategy and has already led to a significant reduction of CO₂ emissions in Europe.

January 2021 saw the start of the national Emissions Trading Scheme (nEHS) in Germany which began to charge for CO₂ emissions by introducing emission rights for Germany. It applies to the heating and transport sectors. These sectors are not covered by the EU-ETS and therefore Germany decided to include them in a national scheme.

For every tonne of CO₂ that can be released during the combustion of fuel, an nEHS certificate must be surrendered. So the system works like EU emissions trading - but only for Germany.

Emissions trading compared internationally

Compared internationally, the EU has introduced one of the most advanced emissions trading systems. Other parts of the world, such as Canada, Australia and China, also created their own trading systems to help reduce CO₂ emissions.

Overall, it is important to note that emissions trading is a functioning system that has been introduced in several parts of the world and has been successful in reducing CO₂ emissions there.

Emissions trading in shipping

Emissions trading is also an important issue in shipping. The International Maritime Organization (IMO) has already introduced measures to limit CO₂ emissions from ships.

From 2024 onwards, all ships calling at European ports will gradually be included in emissions trading. After a three-year phase-in period, during which the percentage of shipping emissions charged will be increased from 40 percent in 2024 to 70 percent in 2025 and 100 percent in 2026, all emissions from shipping within Europe will be covered by the Emissions Trading System.

Summary of the main points

Emissions trading in brief

Emissions trading is a system where companies have emission rights which allow them to emit a certain amount of CO₂. Should they exceed this amount, they have to buy more CO₂ rights.

The aim is to limit CO₂ emissions and promote climate protection. Companies from certain sectors, including energy, industry and aviation, must participate. The price for emission rights varies and depends on supply and demand.

Future prospects for emissions trading

As emissions trading is proving to be successful, it is likely that it will be further expanded and improved to achieve an even more holistic regulation of CO₂ emissions.

Can policymakers not simply end EU emissions trading?

No, it is very difficult to overturn the EU Emissions Trading System. All EU countries would have to agree to it and the EU would then no longer be able to comply with the Paris climate agreement. This scenario is unrealistic.

You can compare it to the likelihood of us suddenly abolishing the euro as a means of payment.

Final assessment of emissions trading from ForTomorrow’s perspective

Overall, we believe that emissions trading is an important step towards successful climate protection.

The EU Emissions Trading System works well, but it is just not working fast enough if we want to reach the 1.5 degree target. We have known this since before the last IPCC report: We need to achieve carbon neutrality much sooner than 2050, otherwise we risk global warming of more than 1.5 degrees and will have to deal with serious consequences.

At ForTomorrow, we buy CO₂ emission rights away from e.g. coal-fired power plants so that they have a lower CO₂ emission allowance. This way, we lower the amount of CO₂ that can be emitted in the EU and protect the climate. We want to make the EU climate neutral before 2040. Help us achieve this by offsetting CO₂ with us.