European Union - Emission Trading System (EU ETS)

To understand EU ETS, we must understand a few aspects related to climate change. The following few paragraphs deal with the issue of climate change and the subsequent paragraphs deal with the EU ETS.

As per Intergovenmental Panel on Climate Change (IPCC), human activities are estimated to have caused approximiately 10C of global warming above pre-industrial levels (1890s). The range is between 0.8 and 1.2. Global warming due to humans is likely to reach 1.50C between 2030 and 2052. If it reaches this level, the following will be the impact.

General Impact Impact on Oceans (Seas) Impact on Land

So what is the solution?

Under the UNFCC (United Nations Framework Convention on Climate Change) many countries have agreed to the adoption of the following protocols. The parties to these agreements have committed themselves to reduce the greenhouse gases as per the recommendations made by the IPCC (Intergovernental Panel on Climate Change).

Under the Paris Agreement (2015), 196 countries came together to commit themselves to reduce greenhouse gas emissions and to limit global warming due to human activity to below 1.50C.

Procedure for Solution

Every nation which is a signatory to the Paris Agreement is required to prepare, communicate and maintain "Nationally Determined Contributions (NDCs)"" that it intends to achieve. Countries are free to find their own ways to meet the targets.

Methods available to countries to meet targets

  1. Command and Control approach
  2. A standard command and control approach may mandate a standard limit per installation, but provide little flexibility to companies as to where and how emission reductions take place.

  3. Tax System
  4. A tax system does not guarantee that the CHG emissions reduction target will be achieved in a multi-national system. It is very difficult to authorities to determine the right price of carbon and hence may under or over charge companies.

  5. Cap and Trade System
  6. A cap and trade system may be beneficiial because it provides certainity about quantity (it is easy to ascertain the overall quantity of carbon emissions for a period of time). It is cost effective as well as trading will reveal the true price. The revenue received from allocation of auctioning of carbon credits gives a source of revenue to governments. It also minimises risk to member state budgets as the member states will not need to purchase additional international units to meet their commitments under Kyoto Protocol.

Some Key Terms

Greenhouse gases
They are those that absorb and emit infrared radiation in the wavelength range emitted by Earth. Non-greenhouse gases


The EU ETS is a "Cap and Trade" system. It caps the total volume of Greenhouse Gases (GHG) emissions responsible for around 50% of EU GHG emissions. It is the first and the largest emissions trading system in the world. It covers roughly 11,000 power stations and industrial units.

The EU ETS is implemented in phases. The first phase which started in 2005 and ended in 2007 was a pilot project. The second phase which started in 2008 and ended in 2012 is for compliance with the 1st commitment under Kyoto Protocol, the third phase which started in 2013 and will end in 2020 is for compliance with the 2nd commitment of Kyoto Protocol, and the fourth phase which will start in 2021 will be an additional commitment undertaken by the EU.

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The EU ETS is an environment law and, therefore, falls within European powers. The decisions about the EU ETS are made at the European level rather than at Member State level. They key institutions involved for the law are the European Parliament (the elected representatives of European citizens), the European Commission (Europe's civil service), and the European Council (the representatives of member governments in Europe's decision making).

EU Emissions Target

The international community has agreed that global warming should be kept below a 20C increase, as compared to the temperature in pre-industrial times (1890s). The following are the EU targets that need to be met by 2020, also known as ("20-20-20" target):
EU Targets to be met by 2050

How does the ETS work?

The system caps the overall emissions of all participants in the system. Emission allowances are provided to participants in the system. Allowances are rights to emit GHG emissions. Each allowance is a right to emit 1 tonne of CO2. The level of cap determines the total number of allowances available in the whole system. The cap is designed to decrease annually from 2013 by 1.74% per year. Some allowances are given for free, while others are auctioned.

Let's say 100 allowances each were given to firm A and B. 100 allowances means the right to emit 100 tonnes of CO2 annually. If firm A emits 90 tonnes in a particular year while firm B emits 110 tonnes, we have a situation where firm A has surplus of 10 emission allowances while firm B has deficit of 10 emission allowances. Firm B can buy 10 emissions from firm A through a bilateral deal (OTC market) or buy them from an exchange where emissions are listed and traded (such as European Energy Exchange - EEX and ICE, London).

Products Available

Phases and Inclusions

Key Features Phase 1 (2005-2007) Phase 2 (2008-2012) Phase 3 (2013-2020)
Geography EU 27 EU 27 + Norway, Iceland, Liechtenstein EU 27 + Norway, Iceland, Liechtenstein
Croatia from 01.01.2013
Aviation from 01.04.2014
  • Power stations and other combustible plants >= 20MW
  • Oil refineries
  • Coke ovens
  • Iron and Steel plants
  • Cement clinker
  • Glass
  • Lime
  • Bricks
  • Ceramics
  • Pulp
  • Paper and Board
Same as Phase 1 + Aviation from 2012 Same as Phase 1 +
  • Aluminium
  • Petrochemicals
  • Aviation from 01.01.2014
  • Ammonia Nitric, Adipic, Glyoxlic acid production, CO2 capture, transport in pipelines and geographical storage of CO2.
GHGs CO2 CO2, N2O emissions via opt-in CO2, N2O, PFC from aluminium production
Cap 2058 million tCO2 1859 million tCO2 2084 million tCO2 in 2013, decreasing in a linear way by 38 million tCO2 per year.
Eligible Trading Units (ETUs) European Union Allowances (EUAs) EUAs, CERs and ERUs

Not eligble: Credits from forestry and large hydropower.

Not eligible: CERs and ERUs from forestry, HFC, N20 or large hydropower projects.
Note: CERs from projects registered after 2012 must be from Least Developed Countries.

Key Features of the EU ETS


Updation History
First updated on 8th August 2020.