The EU Emissions Trading System (EU ETS) is a carbon market mechanism used within the European Union. It is based on a cap-and-trade system that applies to energy-intensive industries, electricity generation, and civil aviation. It is the world’s first and largest carbon market. Under the system, certain major emitters of harmful greenhouse gases are required to hold or purchase a permit (emissions allowance) for every tonne of carbon dioxide they emit. The total number of emission allowances issued annually by the EU is lower than the actual emissions, which creates a market where companies are incentivized to reduce their emissions and sell any surplus allowances to others in need. In essence, emissions trading is the trading of emission rights. The system covers over 10,000 power plants, industrial facilities, and airlines across the EU. Emissions trading is the EU’s most important tool for achieving emission reductions. Since the EU ETS was launched in 2005, EU emissions have decreased by 41%.
The purpose of emissions trading is to ensure that greenhouse gas emissions from industrial and energy production facilities, as well as from intra-European Economic Area air traffic, remain within the emission cap set for the entire EU emissions trading sector.
In Finland, emissions trading is based on the EU Emissions Trading Directive and its implementation through the national Emissions Trading Act (8 April 2011/311). The fundamental principle of the system is that
- Greenhouse gas emissions are reduced where it is most cost-effective to do so
- If emission allowances available on the market are cheaper than the emission reduction measures within the company’s own production, it is more cost-effective to purchase the allowances instead
- Emission reduction measures that are cheaper than the price of emission allowances are worth implementing.
The emissions trading system covers large industrial installations, plants with a total thermal input of over 20 MW, and intra-European Economic Area air traffic. In Finland, the system also includes district heating plants with a capacity of 20 MW or less. In total, just over 500 installations are included in the system in Finland.
Emission allowances can be freely bought and sold on EU-wide markets. There are several exchanges in Europe where emission allowances are traded, and trading also takes place over-the-counter directly between companies. The price of an emission allowance is determined by market supply and demand. Allowances are stored and transferred within the Union Registry, a shared system used by all EU member states.
Emission allowances are issued partly through auctions and partly by allocating them for free to operators according to harmonized free allocation rules. In Finland, the national emissions trading authority is the Energy Authority, which is responsible for permitting, registry, supervision, and the auctioning of allowances. The Energy Authority also approves emissions trading verifiers. Emissions trading for the aviation sector in Finland is handled by the Finnish Transport and Communications Agency, Traficom.
Operators covered by the emissions trading system must have an operator holding account for each installation that has an emissions permit. Similarly, each airline included in the emissions trading system must have an aircraft operator holding account in the Union Registry. Verifiers of emissions must also have their own account. In addition to these mandatory accounts, the Union Registry includes various voluntary accounts for trading purposes. These accounts can, under certain conditions, also be opened by organizations and individuals not covered by the emissions trading system.
The price paid for emission allowances provides an incentive to reduce emissions and encourages investments in low-emission technologies.
The EU Emissions Trading System operates on a “cap and trade” principle. A cap is set on the total amount of emissions allowed from the sectors covered by the system, and this cap is gradually reduced over time, leading to a steady decrease in overall emissions. Operators either receive or purchase emission allowances, which they can trade with each other as needed. The limited number of available allowances ensures that they hold value. The price paid for emission allowances provides an incentive to reduce emissions and encourages investments in low-emission technologies. Trading brings flexibility to the system, ensuring that emissions are cut where it is most cost-effective to do so.
After each year, an operator must surrender a number of emission allowances equal to their total verified emissions for that year. Failure to do so results in a financial penalty. If the operator reduces its emissions and has surplus allowances, it can either save them for future use or sell them to another operator.
Revenue from the auctioning of emission allowances is allocated to the EU member states. Between 2012 and 2020, total revenues from EU emissions trading auctions amounted to €57 billion. According to the Emissions Trading Directive, member states are required to use at least 50% of auction revenues for climate- and energy-related projects. Member states must report annually to the European Commission on the amount of revenue collected and how it was used. In practice, during the period 2013–2019, 78% of the revenues were used by member states to support climate and energy development projects.
The majority of emission allowances are auctioned through a common auction platform used by 25 EU member states and three EEA countries (Norway, Iceland, and Liechtenstein). This platform is the European Energy Exchange (EEX), located in Leipzig, Germany. Germany and Poland have opted out of the common auction platform and have designated EEX as their opt-out platform instead. The opt-out mechanism allows a member state to exclude certain installations from the system, provided that those installations reduce emissions by other means. Poland is currently using this opt-out platform to auction its emission allowances.
The EU Emissions Trading System covers the following sectors and gases, focusing on emissions that can be measured and reported as accurately as possible:
- Carbon dioxide (CO₂)2
- Electricity and heat production
- Energy-intensive industrial sectors, including oil refineries, steel plants, and the production of iron, aluminium, metals, cement, lime, glass, ceramics, pulp, paper, cardboard, acids, and bulk organic chemicals.
- Intra-European Economic Area (EEA) flights and outbound flights from the EEA to Switzerland and the United Kingdom.
- Nitrous oxide (N₂O) from the production of nitric, adipic and glyoxylic acid, and glyoxal.2O typpi-, adipiini ja glyoksyylihapon ja glyoksaalin tuotanto
- Perfluorocarbons (PFCs) from aluminium production.
Participation in the EU Emissions Trading System is mandatory for companies in these sectors, but
- in some sectors, only operators exceeding a certain size threshold are included
- certain smaller installations can be excluded if governments implement fiscal or other measures that reduce their emissions by equivalent amounts (opt-out)
- In the aviation sector, emissions trading between 2013 and 2023 applies only to flights between airports located within the European Economic Area.
In the first aviation phase of the EU Emissions Trading System, which began in 2012, the total amount of aviation emission allowances was set at 97 percent of the average emissions from 2004 to 2006. For the second phase starting in 2013, this cap was tightened to 95 percent of the 2004–2006 average. In the third phase, starting in 2021, the total number of aviation allowances is reduced annually using a linear reduction factor of 2.2 percent. Free emission allowances will be gradually phased out of the emissions trading system by 2034.
According to EU climate policy targets, emissions from sectors covered by the Emissions Trading System are to be reduced by 62 percent by 2030, compared to 2005 levels. The EU Emissions Trading System has proven to be an effective tool for cost-efficient emission reduction. Operators covered by the system reduced their emissions by approximately 35 percent between 2005 and 2021.
Operators covered by the Emissions Trading System reduced their emissions by approximately 35 percent
in years 2005-2021.
The reform of the third phase (2013–2020) of the Emissions Trading System introduced several changes compared to phases 1 and 2. The main changes were:
- A single EU-wide emissions cap replaced the previous system of national emission limits.
- Auctioning became the default method for allocating emission allowances instead of free allocation.
- Harmonised allocation rules, which continue to apply to emission allowances granted for free.
- Additional sectors and gases were included in the system.
- The system reserved 300 million emission allowances to finance the deployment of innovative renewable energy technologies and carbon capture and storage for new entrants.
Greenhouse gas emissions monitoring and reporting must be comprehensive, transparent, consistent, and accurate for the Emissions Trading System to function effectively. Industrial installations and aircraft operators covered by the EU Emissions Trading System must have an approved monitoring plan for the annual tracking and reporting of emissions. Operators are required to submit an annual emissions report, which must be verified by an accredited verifier. After verification, operators must surrender a corresponding number of emission allowances by April 30 of the following year to match their actual emissions. A fine of €100 is imposed for each tonne of emissions for which allowances are not surrendered on time. The names of penalized operators are also published. According to data published by the Energy Authority from recent auctions, the latest general allowance price in August 2023 was €86 per tonne of CO₂.2.
A surplus of emission allowances has accumulated in the EU Emissions Trading System since 2009. This surplus has led to lower allowance prices and, consequently, a weaker incentive to reduce emissions. In the long term, it may undermine the system’s ability to achieve more ambitious emission reduction targets in a cost-effective manner. As one measure, the Commission postponed the auctioning of 900 million allowances to 2019–2020. This did not reduce the total number of allowances auctioned during phase 3 but only altered their distribution over time. As another measure, the Commission reduced the number of allowances to be auctioned in 2014–2016, helping to rebalance supply and demand in the short term.
As a long-term solution, the Market Stability Reserve (MSR) began operating in January 2019. Under this mechanism, the number of emission allowances auctioned during the trading period was adjusted, and the 900 million allowances deferred in 2014–2016 were transferred to the reserve instead of being auctioned in 2019–2020. All unallocated allowances were also transferred to the reserve. From 2019 to 2023, the percentage of total allowances in circulation to be transferred to the reserve was temporarily doubled from 12% to 24% if the surplus exceeded the threshold of 833 million unused allowances. Starting in 2021, the total amount of emission allowances decreases annually by 2.2%, compared to the 1.74% annual reduction applied from 2013 to 2020. This reduction rate is designed to align with the EU Green Deal target of at least a 40% cut in greenhouse gas emissions by 2030.
The total number of emission allowances is decreasing at an annual rate of 2.2% starting from 2021.
On 14 July 2021, as part of the EU’s Fit for 55 package, the European Commission presented proposals to amend the EU Emissions Trading System (EU ETS) Directive, including specific changes related to aviation. The Fit for 55 package is a set of legislative proposals aimed at ensuring that EU policies align with the climate targets agreed upon by the European Council and the European Parliament. The reform seeks to respond to the tightening of emission reduction targets and to expand the impact of emissions trading to new sectors. The directive amendments must be transposed into national legislation by 31 December 2023.
The reform tightens the general EU ETS emission reduction target by 19 percentage points to 62% below 2005 levels by 2030. In addition, the scope of the emissions trading system is expanded to include emissions from maritime transport. Waste incineration plants are also required to begin monitoring and reporting their emissions.
As the emission reduction target becomes more stringent, the criteria for free allocation are also being revised. In the future, operators receiving free allowances must demonstrate that they are implementing emission reduction measures in order to receive the full allocation. The gradual introduction of the Carbon Border Adjustment Mechanism (CBAM) will reduce free allocation in sectors covered by CBAM starting in 2026. Furthermore, installations where more than 95% of emissions result from the combustion of sustainable biomass will be excluded from the scope of the EU ETS. The reason for this is related to the allocation of free allowances.
The adoption of emission-reducing and zero-emission technologies is particularly encouraged through changes to the free allocation rules or detailed amendments to the scope of the directive related to it. In the future, as zero-emission installations operating in sectors listed in the directive will also be included in the EU ETS, these installations will have the opportunity to benefit economically from emissions trading, as they will be eligible to apply for free allocation for their production.
From January 1, 2024, maritime transport will be gradually integrated into the EU Emissions Trading System (EU ETS). Member states have significant national discretion regarding the application of the island exemption. In Finland’s case, implementing the island exemption would mean that passenger ships operating between the mainland and Åland would be excluded from maritime emissions trading during the years 2024–2030.
Lentoliikenteessä Emissions trading already in place for air transport will be enhanced starting January 1, 2024. The climate impact of emissions trading will be increased by gradually phasing out the free allocation of emission allowances and by reducing the total number of allowances. A support mechanism for the use of renewable aviation fuels will be added to the emissions trading system, aiming to increase the use of more sustainable aviation fuels and promote emission reductions by narrowing the price gap between fossil and renewable fuels.
According to the European Commission, a separate emissions trading system will be created for buildings, road transport, and other mainly small-scale industrial sectors that are not covered by the current EU Emissions Trading System. This new system, focused on fuel combustion, will complement the European Green Deal policies by ensuring cost-effective emission reductions. It will apply to fuel suppliers, rather than directly to households or individual motorists.
The new system is intended to be fully operational starting in 2027, although reporting will begin as early as 2025. The target is to achieve a 42% reduction in emissions by 2030 compared to 2005 levels. Revenues from the auctioning of emission allowances under the new system will go directly to the Member States and must be used for climate and social purposes.
Reading the above, it becomes clear that the EU Emissions Trading System (EU ETS) is a highly comprehensive, complex, and constantly evolving mechanism that has already proven its effectiveness and functionality. For this reason, it is both necessary and meaningful to continuously improve and develop the system. The European Commission is strongly committed to this process. The Emissions Trading Directive, along with its amendments and supplements, is binding on the Member States, which are obligated to transpose them into their national legislation. In doing so, the system remains efficient and ensures that Member States and their citizens are treated as fairly and equally as possible.
Main references: https://energiavirasto.fi/paastokauppa European Commission. (n.d.) EU Emissions Trading System (EU ETS). https://climate.ec.europa.eu/eu-action/eu-emissions-trading-system-eu-ets_en Liikenne- ja viestintävirasto Traficom. (n.d.). EU:n lentoliikenteen päästökauppa. https://www.traficom.fi/fi/liikenne/ilmailu/eun-lentoliikenteen-paastokauppa Työ- ja elinkeinoministeriö. (n.d.). Päästökauppa. https://tem.fi/paastokauppa Valtioneuvosto. (2019). Luettelo päästökaupan ilmaisjakoa hakevista laitoksista toimitettu komissiolle. https://valtioneuvosto.fi/-//1410877/luettelo-paastokaupan-ilmaisjakoa-hakevista-laitoksista-toimitettu-komissiolle Valtioneuvosto. (2023). Päästökauppadirektiivi uudistui: kiinteitä laitoksia, merenkulkua ja lentoliikennettä käsittelevät arviomuistiot lausunnolle. https://valtioneuvosto.fi/-/1410877/paastokauppadirektiivien-paivitysten-kiinteita-laitoksia-merenkulkua-ja-lentoliikennetta-kasittelevat-arviomuistiot-lausunnolle Ympäristöministeriö. (2002). Ympäristöneuvostossa sopu EU:n sisäisestä päästökaupasta. https://ym.fi/-//10184/ymparistoneuvostossa-sopu-eu-n-sisaisesta-paastokaupasta
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