EU Emissions Trading System · Glossary

Basic principle: limit the quantity, form the price

The EU Emissions Trading System, or EU ETS, is the European Union's central quantity-based instrument for limiting greenhouse gas emissions. It follows the "cap and trade" principle. An EU-wide cap determines how many greenhouse gases the covered installations and operators may emit in total. For every tonne of CO₂ equivalent emitted, an operator must surrender an emission allowance. The allowances are auctioned or, in certain cases, allocated free of charge. Afterwards they can be traded freely. What is traded is therefore not the emissions themselves, but rights to emit a certain quantity within the cap. Those who can avoid emissions cheaply need fewer allowances or sell surplus ones. Those who cannot must buy more.

The reference unit is the tonne of CO₂ equivalent. It makes different greenhouse gases comparable according to their climate impact. The EU ETS is mainly about CO₂, but depending on the activity also covers nitrous oxide and perfluorocarbons. Since its start in 2005, the system has been further developed over several trading periods. Today the EU ETS 1 covers electricity and heat generation, energy-intensive industry, aviation within Europe and, since 2024, also maritime transport.

Cap and reduction path

Since 2013, a single EU-wide cap has applied to power plants and industrial installations. It falls every year by a linear reduction factor. With the 2023 reform (Directive (EU) 2023/959 amending Emissions Trading Directive 2003/87/EC), this factor rose from 2.2 percent to 4.3 percent per year for 2024 to 2027 and to 4.4 percent from 2028. In addition, the cap was lowered twice on a one-off basis: by 90 million allowances in 2024 and by 27 million in 2026. The aim is to reduce emissions in the covered sectors by 62 percent by 2030 compared with 2005. Previously, 43 percent had been envisaged. A separate cap is calculated for aviation.

The rules for the period after 2030 are not yet final. In 2026 the European Commission proposed a revision of the EU ETS intended to align the system with the EU climate target for 2040. Accordingly, the reduction factor is to be 3.7 percent from 2031 and 1.7 percent from 2036 to 2040. New allowances would thus be issued into the 2040s. This is a proposal, not applicable law. Parliament and Council still have to adopt it.

Distinction from the carbon tax and other instruments

The EU ETS is a form of carbon pricing, but differs from a carbon tax. A tax fixes the price. How much is actually emitted then results from the reactions of market participants. With emissions trading it is the other way round: the quantity is the anchor. The carbon price results from scarcity, expectations, fuel prices, the economic cycle, political rules and demand for allowances.

The EU ETS must also be distinguished from the national coal phase-out, from the support of renewable energy and from regulatory limit values. A coal phase-out regulates whether certain power plants may still operate. Support instruments improve the revenues of certain technologies. Emissions trading makes emission-intensive generation more expensive. These instruments influence one another. If a country additionally shuts down power plants, allowances initially become available within the fixed cap that could be used elsewhere. The Market Stability Reserve and the possibility for Member States to cancel allowances in the event of closures dampen this displacement effect. How strongly these mechanisms work in an individual case, however, depends on their concrete application.

Effect on the power system

In the power sector, the EU ETS mainly affects fossil-fuel power plants. Anyone generating electricity from coal, natural gas or oil must pay for allowances in addition to fuel and operating costs. This raises the short-term marginal costs and thus the bids on the electricity market. In this way the EU ETS acts directly on the merit order, i.e. on the order in which power plants are dispatched. A rough example calculation: depending on efficiency, a lignite power plant emits about 1.0 to 1.2 tonnes of CO₂ per megawatt hour of electricity, a modern combined-cycle gas-fired power plant about 0.35 to 0.4 tonnes. At an allowance price of 80 euros per tonne, lignite incurs roughly 80 to 95 euros per megawatt hour in addition, a gas-fired plant roughly 30 euros. The values are orders of magnitude, not plant data. If the carbon price rises, the position of coal therefore deteriorates more than that of gas. Wind and solar plants need no allowances in operation. How the costs of gas and electricity, including CO₂, relate to each other is shown by the clean spark spread.

This effect does not follow a fixed formula, however. A particular carbon price does not automatically lead to a particular power plant fleet. Fuel prices, efficiencies, grid bottlenecks, availability, demand and weather all act at the same time. A high gas price can partly erode the economic climate advantage of gas over coal. According to the Commission, electricity and heat generation contributed most to the fact that emissions in the EU ETS fell by around 47 percent by 2023 compared with 2005.

Allowance costs feed into the electricity price when fossil-fuel power plants set the market price. This also applies to electricity from installations that themselves need no allowances, because the price on the spot market is the same for everyone. With a lot of wind and solar power, fossil-fuel power plants set the price less often, but still do so in certain hours. The carbon price then makes precisely these emission-intensive hours more expensive. As a result, the price differences between clean and emission-intensive hours grow. This improves the profitability of storage, load shifting and other flexibility, even though the EU ETS itself is not a flexibility instrument.

Auctioning, free allocation and opportunity costs

Auctioning is the standard procedure. Since 2013, electricity generators have in principle no longer received free allowances and must buy them at auction or on the market. One exception is a time-limited rule for some Member States with lower income: they were allowed to allocate allowances free of charge to their energy sector, combined with investments in modernisation. In 2020 the European Court of Auditors doubted that this allocation in phase 3 promoted decarbonisation. Energy-intensive industry continues to receive free allowances based on benchmarks in order to prevent the relocation of production abroad (carbon leakage). Since the reform, part of this has been subject to conditions. Where the carbon border adjustment mechanism CBAM is introduced, free allocation is phased out gradually. In aviation it ends from 2026; in maritime transport there is none.

Allowances allocated free of charge are not worthless either. Anyone who does not need an allowance for their own emissions can sell it or keep it for later. The market price therefore reflects opportunity costs and feeds into operational decisions, even if nothing was paid for the allowance.

Market Stability Reserve and institutional framework

The EU decides on the framework: which sectors are covered, how fast the cap falls, how allowances are auctioned and allocated, and what happens to surpluses. After the 2008 economic crisis, large surpluses had accumulated. They were first reduced by withholding auction volumes (backloading) and, since 2019, by the Market Stability Reserve (MSR). The MSR adjusts the auction volume in a rule-based manner to the number of allowances in circulation and was changed again with the 2023 reform. Parts of the cap are also reserved for the Innovation Fund, the Modernisation Fund and the Social Climate Fund. Without monitoring, reporting obligations, registries and sanctions, there would be no reliable trading. The EU ETS is therefore not the opposite of regulation, but a form of regulated scarcity.

What the EU ETS does not cover

The EU ETS 1 does not cover all emissions. For fuels in buildings and road transport, as well as for further sectors, the 2023 reform creates a separate system, the EU ETS 2. It was originally to start in 2027. In November 2025, the EU environment ministers and the European Parliament agreed to postpone the start to 2028. Until then, national rules apply, in Germany the carbon pricing under the Fuel Emissions Trading Act (BEHG). Different rules apply to agriculture and land use. In the power system, the EU ETS does not pay for grids, does not replace reserve power plants, does not solve permitting problems and does not guarantee security of supply.

Investment and distributional questions

The EU ETS affects investment mainly through expectations. Power plant operators, industrial companies and storage investors calculate not only with today's price, but with future scarcity. The more credible the reduction path, the less plannable coal-fired generation becomes and the more attractive low-emission processes become. In industry these include, for example, electrification, hydrogen, efficiency measures or carbon capture, insofar as they are technically and legally possible. Political debates about interventions or postponements can weaken these expectations.

The EU ETS makes part of the climate costs of fossil-fuel generation visible in the market. As a result, prices for consumers may rise. At the same time, the distortion that arises when emissions cost nothing becomes smaller. Auctioning brings the state revenue that can be used, for example, for climate action or relief measures. How it is used is a political question of distribution. The climate effect itself arises from the limited quantity of allowances. The EU ETS thus translates climate targets into quantities, prices and operational decisions. On its own, however, it does not explain the level of the electricity price, security of supply or grid expansion.

Sources

EU ETS emissions cap — Europäische Kommission, GD Klimapolitik; unbekannt. Abschnitt „About the EU ETS emissions cap“
EU-Emissionshandel verstehen — Deutsche Emissionshandelsstelle (DEHSt) im Umweltbundesamt; unbekannt. Abschnitte „Emissionshandel und Klimaschutz“ und „Wie funktioniert der Emissionshandel?“
Emissionshandelssystem: kostenlose Zuteilung von Zertifikaten gezielt vornehmen (Sonderbericht 18/2020) — Europäischer Rechnungshof; 2020. Zusammenfassung und Glossar
Questions and answers on the EU Emissions Trading System (EU ETS) review — Europäische Kommission; 2026 (genaues Datum unbekannt). Abschnitt zum Linear Reduction Factor
Emissionshandel: ETS, ETS2 und CO2-Preis erklärt — BDEW Bundesverband der Energie- und Wasserwirtschaft; unbekannt (vermutlich Ende 2025). Abschnitt „ETS2 – neuer Handel für Wärme und Verkehr“

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Edited by eCMS on 11.11.2026 19:47