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Glossary · Energy industry & energy transition

Emissions trading

Glossary Climate CO2 Emissions Trading electricity market regulation EU ETS Carbon price

Emissions trading is a climate policy instrument based on the "cap and trade" principle. Anyone who emits greenhouse gases needs emission allowances for this, which can be traded. The legislator sets a cap on the total permitted quantity. Within this limit, companies can buy allowances at auction, receive them free of charge, buy them, sell them or use them to meet their own surrender obligation. The climate effect results from the limited quantity. The economic incentive results from the price that forms for these scarce allowances. Strictly speaking, therefore, it is not emissions that are traded, but rights to emit a certain quantity.

Unit, surrender obligation and penalty

In the EU system, one allowance permits the emission of one tonne of CO₂ or one tonne of CO₂ equivalent. CO₂ equivalents make it possible to compare different gases by their climate impact. In industrial installations, for example, nitrous oxide from nitric acid production or perfluorinated hydrocarbons from aluminium production are also subject to the obligation. In the EU ETS 1, the deadlines work as follows: operators determine their emissions of the previous year by the end of March and have them verified by accredited verifiers. By the end of September they must surrender the corresponding number of allowances in the Union Registry. The registry is an electronic account system, because allowances exist only virtually.

Anyone who surrenders fewer allowances than they have emitted pays a penalty. It amounts to 100 euros per tonne of CO₂ equivalent not covered and has risen with the European consumer price index since 2013. For the reporting year 2022, according to the German Emissions Trading Authority, it was around 121 euros. Importantly, the penalty does not replace allowances. Missing allowances must still be surrendered afterwards. One therefore cannot buy one's way out of the quantity limit by paying. Anyone who emits less can sell surplus allowances or keep them for later years.

Quantity control instead of price control

Emissions trading and a CO₂ tax differ in what the state sets. With a tax, it determines the price per tonne. How many emissions are avoided as a result then depends on the behaviour of market participants. With emissions trading, the state limits the quantity. The CO₂ price then results from scarcity. It also depends on expectations, the economic cycle, fuel prices, technological progress and political interventions. Both forms are part of carbon pricing. However, they have different properties: a tax gives planning certainty on price, a cap gives certainty on quantity. There are also hybrid forms, for example fixed entry prices or price corridors.

The EU emissions trading system

For the European electricity system, the EU emissions trading system (EU ETS 1) is particularly important. It applies in all 27 member states as well as in Norway, Iceland and Liechtenstein and is linked to the Swiss system. Around 9,000 stationary installations are covered. These include fossil-fired power plants, combined heat and power plants and heating plants with a rated thermal input of 20 megawatts or more, as well as energy-intensive industrial installations such as blast furnaces, refineries and cement works. Added to this since 2012 is aviation, mainly flights within the European Economic Area, and since 2024 maritime transport. The "Fit for 55" package tightened the target: by 2030, emissions within the scope are to fall by 62 percent compared with 2005. To achieve this, the cap falls by 4.3 percent annually, and from 2028 by 4.4 percent, instead of the previous 2.2 percent.

In addition, a separate second system (EU ETS 2) is being created for fuels in buildings, road transport and other sectors. The parties obliged to surrender allowances there are not households, but the companies that place fuels on the market. The start of the full price effect was postponed from 2027 to 2028. Until then, Germany applies the national fuel emissions trading scheme under the Fuel Emissions Trading Act (Brennstoffemissionshandelsgesetz) with prices set by the state or a price corridor.

Effect on the electricity market and power plant dispatch

Operators of fossil-fuelled power plants must surrender allowances for their emissions from coal, gas or oil. They include these costs in their variable generation costs in the same way as fuel costs. A lignite power plant emits about twice as much CO₂ per kilowatt hour generated as a modern combined-cycle gas turbine plant. It is therefore correspondingly more heavily burdened by the CO₂ price. Wind and photovoltaic installations cause no emissions subject to surrender during operation and therefore need no allowances. Traders often assess the interplay of electricity, fuel and CO₂ prices using the clean dark spread for coal and the clean spark spread for gas.

Emissions trading thus acts directly on the electricity market. In the merit order, emission-intensive plants move further back in the cost ranking. The higher the price of allowances, the more often lower-emission power plants are dispatched ahead of more emission-intensive ones. This so-called fuel switch only works if fuel prices, technical availability and grid bottlenecks allow it. Emissions trading therefore influences not only investment calculations over decades, but also the daily dispatch of power plants.

Free allocation and opportunity costs

Allowances are either allocated free of charge or auctioned. Auctions take place almost daily on the EEX energy exchange. In addition, trading takes place continuously on exchanges and over the counter. Auctioning is generally regarded as preferable because it corresponds to the polluter-pays principle. For electricity generation, the EU ETS largely provides no free allocation, but exceptions apply. Energy-intensive industry, by contrast, continues to receive free allowances. They are intended to prevent production from relocating to regions without comparable climate rules. This allocation is now partly tied to conditions and is being phased out gradually for sectors covered by the carbon border adjustment mechanism CBAM. From 2026, aviation and maritime transport no longer receive free allowances.

A common misunderstanding: allowances allocated free of charge are not worthless either. Every allowance has a market value. Anyone who uses them for their own emissions can no longer sell them. These opportunity costs feed into production and pricing decisions. A free allocation mainly reduces the state's auction revenues. The total quantity that must be surrendered nevertheless remains limited.

Market stability reserve and national measures

If a state additionally shuts down coal-fired power plants, demand for allowances initially falls. Without further rules, the allowances thus freed up could be used elsewhere. This effect is often called the "waterbed effect". The EU has created two mechanisms against it:

  • Market stability reserve: It automatically absorbs allowances from the auction volumes when too many are in circulation. Since 2023, holdings in the reserve above a threshold lose their validity. By the beginning of 2025, this amounted to around 3.2 billion allowances in total.

  • Voluntary cancellation: Under Article 12(4) of the Emissions Trading Directive, member states may cancel allowances from their auction volume if they close down electricity generation capacity because of national measures. Germany has announced this for power plants affected by the coal phase-out.

In 2026, the Commission proposed setting a time limit on the rule on loss of validity. Holdings above 400 million allowances would then remain in the reserve instead of becoming invalid. How effective a national measure is for the climate can therefore only be assessed on the basis of the rules on the allowance quantity that apply at the time. The national emissions balance of a single year is not sufficient for this.

Distinction from voluntary offsetting

Regulated emissions trading is something different from voluntary offsetting. There, companies or individuals buy credits for an alleged emission reduction elsewhere. In emissions trading, by contrast, a statutory surrender obligation applies and the total quantity is limited. Whether and to what extent external credits may be counted is decided by policymakers. The environmental credibility of the system depends heavily on this.

Limits for the electricity system

Emissions trading makes fossil generation more expensive. However, it does not replace grid planning, permitting procedures and rules on security of supply. If coal-fired power plants become uneconomic, there is still a need for sufficient generation, storage, flexible demand, grids and reserves to balance consumption and generation at all times. Firm capacity for hours of high consumption and little wind and solar power likewise does not arise automatically from a CO₂ price.

Investments also do not depend on today's allowance price alone. What matters are the expected prices over many years, political credibility, financing costs and the available infrastructure. This concerns, for example, renewable generation, electrification of industrial processes, hydrogen or efficiency measures. Weak investment signals therefore often have their cause in uncertainty about future caps, exemptions and political interventions.

Effect on consumers and use of revenues

Consumers usually notice emissions trading indirectly. In the electricity price, the CO₂ price acts through the wholesale costs of the fossil power plant that is currently setting the price. If a gas-fired power plant sets the price, the mark-up is smaller than with a coal-fired power plant. With a large amount of renewable feed-in, the influence can be small at times. Member states must use their auction revenues from the EU ETS 1 for climate action and for supporting the transformation. In Germany they flow into the Climate and Transformation Fund. At EU level, the Innovation Fund and the Modernisation Fund finance low-emission technologies and poorer member states. Who is ultimately burdened therefore depends both on the price and on how the revenues are used and costs are passed on.

Assessment

Emissions trading is neither a single exchange nor a climate tax under another name. It is a regulatory framework consisting of a cap, allowances, monitoring and verification, a surrender obligation, trading, penalties and adjustment rules such as the market stability reserve. Its strength is the binding quantity limit, combined with the search for the cheapest abatement options. It becomes weak where the cap is too generous, exemptions dilute the signal, social questions remain unresolved or infrastructure is lacking. Whether an electricity system is rebuilt reliably, affordably and fast enough is not explained by emissions trading alone.

Sources

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Edited by eCMS on 11.11.2026 19:45

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