The EU ETS is the worldโs first carbon market, which was established in 2005 and remains among the largest globally. It aims to drive emissions reductions across the EU and to generate revenues to be used towards the green transition. The EU ETS operates in all EU counties as well as Norway, Liechtenstein and Iceland and is linked to the Swiss ETS programme. Companies in industries required to comply under the EU ETS must report their emissions on an annual basis and surrender the corresponding number of allowances to cover their emissions. Since the introduction of the EU ETS, a 47% reduction in emissions has been seen from power and industry in Europe.
How does the EU ETS work?
The EU ETS follows a cap and trade principle. This puts a cap or upper limit on the total amount of greenhouse gas (GHG) emissions that are allowed to be emitted by all operators in the system. This cap is reduced annually. In order to stay within the cap, allowances are created equal to the right to emit 1tCO2e, availability of which decreases alongside the cap. Companies under the ETS are required to purchase and surrender the allowances corresponding to their emissions each year.
Typically, allowances are distributed through auctions to implement the polluter pays principle, although these can also be traded on the secondary market and some allowances are provided as free allocations.
The majority of free allocations are set to be phased out between 2026 and 2030, with allocations remaining for sectors considered at risk of relocation and new or growing installations. Since 2023 all revenues from the EU ETS must be used to support the green transition and any associated social impacts, replacing the prior minimum requirement of 50%. Any allowances purchased by a company exceeding the value they are required to surrender may be kept and used the following year.
To ensure the ETS continues to be effective in reducing emissions, the Market Stability Reserve was introduced in 2018. This was in response to a large surplus in emissions since 2009 and works to regulate the allowances market. If allowances in the market exceed 833 million, the Market Stability Reserve will remove 24% of total allowances from circulation. Alternatively, if allowances in circulation fall below 400 million, 100 million will be released back to the market from the reserve.
Since 2023, a threshold was set over which any additional allowances will be invalidated. In 2024 this threshold was fixed at 400 million leading to over 2.8 billion allowances being invalidated across the two years.
Who must comply?
Industries currently required to comply with the EU ETS are:
- Electricity and heat generation
- Industrial manufacturing, including oil, metals, cement, glass, ceramics, paper products and chemicals
- Aviation within the EES and departing flights with destinations of Switzerland or the UK
- Maritime travel, covering 100% of travel between two EU ports and 50% of travel which either start or end outside the EU.
Installations from the above industry are required to comply with the EU ETS once they hit certain levels of energy use or production, for example for the combustion of fuels installations with a thermal input over 20MW must comply.
CO2 must be calculated by all complaint sectors. N2O must be calculated in the production of nitric, adipic and glyoxylic acids and glyoxal, and PFCs must be calculated in the production of aluminium.
From 2027, a separate emissions trading system (ETS2) will be introduced covering buildings and road transport among the additional sectors expected to comply.
To ensure users of the infrastructure are not negatively impacted, this ETS will apply to upstream emitters placing the responsibility on fuel suppliers who will need to surrender allowances. Revenue from the ETS2 is expected to be provided to EU member states to support vulnerable groups, for example to put in place energy efficiency measures, building renovations or renewable energy infrastructure.
How to comply
Each installation and aircraft operator must monitor their annual emissions using an approved monitoring plan. They must then submit an emissions report, the data from which must be verified by an accredited verifier, by the 31st March the following year and surrender the corresponding allowances by 30th September.
For each tonne of emissions which have not had the relevant allowances surrendered, there is a โฌ100 penalty above the cost of allowances due. Additionally, any operators who are penalised will be publicly disclosed.
Development of the EU ETS
- 2005-2007: Phase 1, only covered CO2 from power generators and energy intensive industries. All allowances were free with a โฌ40 non-compliance penalty.
- 2008-2012: Phase 2, the cap of allowances and number of free allowances given were reduced to align with Kyoto protocol emissions reduction targets and the non-compliance penalty was increased to โฌ100. Norway, Liechtenstein and Iceland were introduced at the beginning of the phase and aviation in January 2012.
- 2013-2020: Phase 3, considerable changes were made during this phase the most significant being: the single EU-wide cap on emissions; auctions becoming the primary method of allocating allowances; free allowances being harmonised across the system; the introduction of further sectors and gasses; and 300 million allowances being put in a new entrantsโ reserve.
- 2020-2030: Phase 4, this is the current phase of the ETS following the compliance detailed above.
The UK ETS
The UK has a similar Emissions Trading Scheme introduced in 2021 after it left the EU which mirrors criteria from the EU ETS. Electricity generators in Northern Ireland remain in the EU ETS as part of the Ireland/Northern Ireland protocol. This scheme is currently in its first phase, 2021-2025, which requires energy intensive industries, aviation routes (domestic and flights departing to the EEA) and power generators to report emissions and surrender the corresponding allowances.
As with the EU ETS this scheme offers a portion of allowances but the majority are sold at auction or can be purchased on the secondary market.
There are two market stability mechanisms to adjust pricing where necessary: an auction reserve price to prevent prices from dropping too low, and a cost containment mechanism to prevent prices exceeding an agreed level of triple the 2-year average for six consecutive months.
There is a slightly faster compliance cycle for the UK ETS. Emissions must be monitored all year, reports verified and published by March the following year and allowances must be surrendered in April.
In the UK scheme there are exemptions for operators below a certain threshold. Hospitals and Small emitters (HSEs), classed as those emitting below 25,000 tCO2e per year with a thermal capacity below 35MW, must reach emissions targets but are not required to purchase and surrender allowances. Ultra-Small Emitters (USEs), emitting below 2,500 tCO2e per year are not required to have a permit to emit but must monitor emissions and inform the regulator if their emissions increase above the threshold.
EU/UK ETS Purchasing allowances
Any organisation which falls under the EU or UK ETS will be required to purchase allowances to cover corporate annual emissions. These can be purchased in auctions through the designated auction system, where authorised account holders can bid a price and desired number of allowances to be purchased. Where there are more bids than allowances being sold, an auction price is set, above which bids are accepted and matching this price bids will be randomly selected.
Auction calendars are available on the relevant online platform, these are every two weeks for UK ETS auctions and on most weekdays for EU ETS auctions.
It is also possible to purchase allowances directly on a secondary market, enabling organisations to purchase at a set price. For EU ETS allowances, these can be purchased through the EEX trading system or via authorised traders. For UK ETS allowances, it is recommended participants contact an energy consultant or specialist commodity trading partner.
How NUS can help
NUSโ Energy and Sustainability (ESS) team can guide you through the entire process of purchasing emission allowances by working with trusted partners to procure the relevant emission allowances best suited to your companyโs needs. For more information contact your local NUS consultant or email UKSustainability@nusconsulting.co.uk.
To see NUSโ wider sustainability and decarbonisation services, click here.