EU Emissions Trading System
The world's largest carbon market. Over 10,000 installations across power generation, heavy industry, aviation, and -- since 2024 -- maritime shipping must monitor, report, and surrender EU Allowances for every tonne of CO2 emitted. In 2027, a separate ETS2 will extend carbon pricing to buildings and road transport.
The EU Emissions Trading System is a cap-and-trade market. The EU sets a ceiling on total CO2 emissions from heavy industry and power generation, issues a limited number of pollution permits (called EU Allowances), and forces companies to buy or trade those permits for every tonne of CO2 they emit. If the cap goes down, permits become scarcer, prices go up, and companies have a financial incentive to cut emissions. It is the world's largest carbon market, covering over 10,000 installations across Europe.
Since its launch in 2005, the system has gone through four phases and several major reforms. The most recent overhaul, adopted in 2023 as part of the Fit for 55 package, sharply accelerated the cap reduction -- from 2.2% per year to 4.3% per year -- targeting a 62% cut in covered emissions by 2030 compared to 2005 levels. Maritime shipping was brought in starting in 2024, and free pollution permits for sectors like steel, cement, and aluminium are being phased out between 2026 and 2034 as the Carbon Border Adjustment Mechanism (CBAM) takes over.
A second, parallel system called ETS2 is set to launch in 2027, extending carbon pricing to buildings, road transport, and small industrial sites. Because these costs will ultimately hit households and drivers, the EU created a Social Climate Fund worth EUR 86.7 billion to soften the blow through energy efficiency investments, clean heating, and direct support for vulnerable families.
The carbon price fluctuates with the market. After years in the single digits, EU Allowance prices surged past EUR 80 in 2022-2023 on the back of tighter supply rules and the Market Stability Reserve. Prices have since settled in the EUR 55-80 range. For any company operating or importing into the EU, the direction of travel is clear: the cost of emitting CO2 is going up, the number of free permits is going down, and the scope of covered sectors is expanding.
Average annual EU Allowance prices. Hover for details.
The EUA price rose from ~EUR 5 in 2017 to ~EUR 100 in early 2023 -- driven by the Market Stability Reserve (2019), the Green Deal (2020), and the Fit for 55 package (2023). Since mid-2023, prices have stabilised in the EUR 55-80 range as industrial output softened and the MSR absorbed the surplus.
Launched in 2005, the EU Emissions Trading System is the world's first and largest international carbon market, covering approximately 40% of the EU's total greenhouse gas emissions. Operating on a cap-and-trade principle, the ETS sets a declining cap on total emissions from covered installations, while allowing companies to trade emission allowances among themselves. This market mechanism creates a financial incentive for emission reductions where they are most cost-effective, driving decarbonisation across the European economy.
ETS Phase IV, running from 2021 to 2030, significantly tightened the system following the Fit for 55 legislative reforms. The annual reduction factor for the emissions cap was increased to 4.3% from 2024 and 4.4% from 2028, accelerating the path toward the EU's target of at least 55% emissions reduction by 2030. The system now covers approximately 10,000 installations in power generation, manufacturing, and intra-EEA aviation, and a new ETS II for buildings, road transport, and small industry was established to begin in 2027.
Covered operators must monitor and report their verified annual emissions, then surrender a corresponding number of EU Allowances (EUAs). Allowances are distributed through a combination of auctioning and free allocation, with free allocation being gradually phased out for sectors covered by CBAM. Companies that reduce emissions below their allocation can sell surplus allowances on the carbon market, while those exceeding their allocation must purchase additional allowances or face penalties of 100 euros per excess tonne, adjusted for inflation.
The interaction between the ETS and the Carbon Border Adjustment Mechanism is particularly significant. As CBAM comes into full effect from 2026, free allocation under the ETS for CBAM-covered sectors will be progressively reduced, ensuring a smooth transition from border-free carbon pricing within the EU to a system where both domestic producers and importers face equivalent carbon costs. This alignment is designed to maintain competitive fairness while preventing carbon leakage.
For businesses, the ETS represents both a compliance cost and a strategic opportunity. Companies that invest in low-carbon technologies and energy efficiency can generate value through reduced allowance purchases or surplus sales. The system's interaction with the EU Taxonomy helps companies demonstrate that their investments and activities contribute to climate mitigation objectives, reinforcing the connection between carbon market compliance and sustainable finance.
The 2023 Fit for 55 reform created a second, parallel emissions trading system. ETS2 targets sectors not covered by the original ETS, using an upstream regulation model.
| FEATURE | ETS1 (ORIGINAL) | ETS2 (NEW) |
|---|---|---|
| Launch year | 2005 | 2027 |
| Sectors covered | Power, industry, aviation, maritime | Buildings, road transport, small industry |
| Number of installations | ~10,000 | ~Est. fuel distributors |
| Regulation point | Installation-level | Upstream fuel supplier |
| Cap reduction factor | 4.3% per year (2024+) | 5.1% per year |
| Free allocation | Yes, phasing out 2026-2034 | No |
| Price ceiling mechanism | None (MSR only) | EUR 45 trigger (extra allowances released) |
| Carbon price (2026) | ~EUR 72/tCO2 | N/A (launches 2027) |
| Revenue use | Innovation Fund, Modernisation Fund | Social Climate Fund (EUR 86.7bn) |
| Entities affected | Heavy industry, power generators, airlines, shipping | Households, SMEs, transport companies (indirectly) |
To offset the impact of ETS2 on households, the EU established the Social Climate Fund with EUR 86.7 billion (2026-2032). Member States must co-finance national Social Climate Plans targeting vulnerable households, micro-enterprises, and transport users. Plans must include at least 37% for direct income support measures and 63% for structural investments in energy efficiency, clean heating, and sustainable transport.
The MSR automatically adjusts allowance supply to maintain price stability and scarcity.
Since its launch in 2019, the MSR has absorbed over 2.5 billion allowances from the market and permanently invalidated approximately 2.5 billion surplus allowances in 2023. This mechanism was the single largest driver of the EUA price increase from EUR 5 (2017) to EUR 80+ (2022-2023).
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