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Glossary · Energy industry & energy transition

Carbon pricing

Carbon pricing Carbon price EU Emissions Trading Climate protection Emissions electricity market Marginal costs merit order

Carbon pricing refers to rules that give emissions of carbon dioxide or other greenhouse gases a monetary value. It is usually measured in euros per tonne of CO₂. Where methane, nitrous oxide or fluorinated gases are also included, the unit is euros per tonne of CO₂ equivalent (CO₂e). The price is meant to make visible costs that, without regulation, are borne by the general public, future generations or other regions of the world: the burden that emissions place on the climate.

Two basic forms: quantity control and price control

In emissions trading, policymakers set an upper limit on total emissions, the so-called cap. Allowances are issued for this quantity, mostly auctioned and partly allocated free of charge. Anyone who emits must surrender one allowance for each tonne of CO₂e every year. The allowances may be traded, and the price is formed by supply and demand. In the EU Emissions Trading System (EU ETS 1), one allowance entitles the holder to emit one tonne of CO₂e. The cap falls every year. After the 2023 reform, it is intended to reduce emissions from the covered sectors by 62 percent by 2030 compared with 2005.

With a carbon tax or carbon levy, the state sets the price per tonne directly. How much emissions fall then depends on how companies and consumers respond to the price. Emissions trading with a tight budget therefore primarily controls quantity. Its price fluctuates because it reflects scarcity, fuel prices, economic conditions, weather, political expectations and available abatement options. A tax offers greater price stability. However, it guarantees a particular quantity of emissions only if the state adjusts it. There are also hybrid forms, such as trading systems with a minimum and maximum price. In political debate, both basic forms are often grouped under the umbrella term carbon price. For investment, electricity prices and emissions reduction, however, the institutional design makes an important difference.

Scope in the EU and Germany (as of November 2026)

The EU ETS 1 has existed since 2005. It applies in all EU states as well as in Iceland, Liechtenstein and Norway, and has been linked to the Swiss system since 2020. It covers power and heat generation, energy-intensive industrial installations and aviation, essentially flights within the European Economic Area. Together these account for around 40 percent of the EU's greenhouse gas emissions. Maritime transport has also been included since 2024, initially for CO₂ only. The obligation to surrender allowances is being phased in there. From 2026, aviation no longer receives free allowances. On 17 July 2026, the European Commission proposed a further revision which, among other things, is intended to change the allocation rules and gradually extend trading to waste incineration plants. This proposal is not yet applicable law.

Building heating and road transport lie outside the EU ETS 1. For them, the EU has adopted a separate system, the EU ETS 2. It was originally due to start in 2027; following an agreement at the end of 2025, the surrender obligation now begins in 2028. Until then, in Germany the Fuel Emissions Trading Act (BEHG) prices fuels such as petrol, diesel, heating oil and natural gas. For 2026, allowances are auctioned within a statutory price corridor of 55 to 65 euros per tonne of CO₂. A government bill amending the BEHG (Bundestag printed paper 21/7869) is intended to fix this corridor for 2027 as well. Without the amendment, the price for 2027 would be derived from the average auction price in the EU ETS 1. The Bundesrat has raised no objections. Whether the act has already been promulgated should be checked before relying on it for 2027. Other countries have their own systems, for example Austria with the NEHG 2022.

Effect in the electricity market: marginal costs and merit order

In the power system, carbon pricing mainly affects fossil-fuelled power plants. When coal, gas or oil plants have to surrender allowances for every tonne emitted, their marginal costs, that is, the cost of generating one additional kilowatt-hour, rise. These costs feed into bids on the electricity market and shift the dispatch order of power plants, the merit order. The allowance price forms part of marginal costs even if an operator received allowances free of charge. An allowance it does not need could be sold, so it has a value for the operator (opportunity costs).

How much the carbon price raises marginal costs depends on the emission factor per kilowatt-hour generated. An example using rough benchmark values: an older lignite plant emits around 1 tonne of CO₂ per megawatt-hour of electricity, while a modern combined-cycle gas plant emits about 0.35 to 0.4 tonnes. At 80 euros per tonne, the generation costs of the lignite plant thus rise by around 80 euros per megawatt-hour, and those of the gas plant by only about 28 to 32 euros. The actual values depend on the fuel and efficiency. If the carbon price is high enough and gas prices are favourable, coal-fired electricity becomes more expensive than gas-fired electricity. The dispatch order then changes, and fuel switching occurs. Wind, solar and hydropower plants burn no fuel in operation and therefore bear no carbon costs. This does not mean that they have no environmental impacts. Carbon pricing covers only the emissions from the operation of the installations covered.

There is no mechanical relationship between the carbon price and the wholesale electricity price. In many hours, the price on the day-ahead market is set by the most expensive power plant still needed. If that is a fossil-fuelled plant, its carbon costs enter the market price. If renewable energy largely covers demand, however, the carbon price has hardly any effect on the electricity price. Fuel prices, demand, grid bottlenecks, power plant availability, storage levels and imports also influence the price. A high electricity price can therefore not simply be attributed to the carbon price. Conversely, a low electricity price does not prove that carbon pricing is ineffective.

Investment signals and distribution of revenues

If a fossil-fuelled power plant with carbon costs sets the market price, wind and solar plants, storage facilities or nuclear power plants in that market area also receive this higher price, even though they themselves bear no corresponding carbon costs. This is not an accounting error but a consequence of uniform price formation. This is precisely how the investment signal for low-emission generation arises. Political questions follow from this: Should windfall profits be skimmed off, long-term contracts promoted, or investment risks distributed differently? Besides climate policy, carbon pricing thus also touches on market design, financing and acceptance.

In the EU ETS 1, the majority of allowances are auctioned. According to the European Commission, the system has raised more than 175 billion euros since 2013. The revenues flow predominantly into national budgets. Contrary to what the earlier version of this entry suggested, they are not available at will for general government spending: the Member States have committed to using all revenues, or an equivalent amount, for climate action and a socially fair transition. Part of the revenue also goes to the EU's Innovation Fund and Modernisation Fund. For the EU ETS 2, a Social Climate Fund is intended to cushion social hardship. How carbon pricing distributes burdens depends not only on the price but also on redistribution, exemptions, free allocation and the ability of those affected to adapt. A household with a heat pump is affected differently from one with an oil heating system.

Limits and common misconceptions

  • Not a mere energy surcharge: Carbon pricing changes which technologies are economically viable relative to one another. It makes emission-intensive generation more expensive, strengthens low-emission plants and can increase the value of flexibility if that flexibility replaces fossil peak load.

  • Not a complete climate policy: A carbon price does not build a power line, does not replace a permitting procedure and does not create missing flexibility. Whether renewable energy is expanded also depends on land, grid connections, support rules, tenders, grid charges and supply chains.

  • Mind the system boundaries: Electrification through heat pumps or electromobility shifts emissions from decentralised combustion to the power sector, which falls under the EU ETS 1. Electricity consumption then rises, while the consumption of fossil energy carriers overall may fall. Until the end of 2027, the power sector and fuels in Germany are priced under different systems and at different prices.

  • Allowance price is not the same as climate damage: The allowance price is the market price of a scarce emission right under the rules in force. It may be lower or higher than estimates of the social cost of a tonne of CO₂.

  • Allowance price is not the same as the household electricity price: Between the two lie the wholesale price, grid charges, taxes, levies, procurement and sales (see components of the electricity price). Anyone who derives the electricity bill directly from the carbon price conflates different levels of price formation.

Distinction from neighbouring concepts

An emission factor indicates how much CO₂ is produced per kilowatt-hour, per litre of fuel or per unit of production. It is the quantity figure by which the carbon price is multiplied. A guarantee of origin certifies that a quantity of electricity comes, in accounting terms, from renewable sources. However, it says nothing about which emissions were avoided in the overall system. Support instruments for renewable energy reduce investment risks but are not a carbon price. Energy and electricity taxes can also steer behaviour, but they are not necessarily based on the carbon content of an energy carrier. The EU's Carbon Border Adjustment Mechanism (CBAM) extends the carbon price to certain imports in order to limit the relocation of emissions abroad (carbon leakage).

In summary, carbon pricing translates emissions into costs. Its effect results from concrete rules on quantities, prices, allowances, market bids and the use of revenues. It changes power plant dispatch, investment and cross-sector decisions, but on its own explains neither the level of the electricity bill nor the success of the energy transition.

Sources

Related glossary entries

Edited by eCMS on 11.11.2026 17:39

© 2026 Erik Schmidt. All rights reserved. Quotations with a link to the source are welcome.