Everyone has probably heard of emissions allowance trading. As we have heard in the media, their price has a significant impact on the price of energy, but their main objective is to help reduce carbon dioxide emissions, the main driver of global climate change. How does European emissions trading work? And how does it differ from the system(s) in the United States or China?
EU ETS helps decarbonise the European Union
The European Union Emissions Trading Scheme (EU ETS), which puts a price on carbon dioxide (CO2) emissions, has been a major driver of decarbonisation in the energy and industrial sectors for many years. The EU is also preparing to introduce a similar scheme, EU ETS II, for the transport and construction sectors. The system's functionality has long been constrained by an oversupply of allowances and their low price, but Europe is now facing the opposite problem. However, it also gives businesses more incentive to reduce their consumption of fossil fuels.
The original ETS I aims to reduce emissions in electricity generation, energy-intensive industries (e.g. iron, aluminium, cement, glass, cardboard, acids, etc.), civil aviation and, from this year, maritime transport by a certain percentage. Under the scheme, companies have to buy "allowances" corresponding to their CO2 emissions, making it more expensive to produce energy from burning coal and other fossil fuels and making clean energy sources more attractive. Heavy industry receives a certain amount of free emission allowances to compete with non-EU companies subject to less stringent climate regulations.
A new EU instrument called CBAM is also intended to help European companies remain competitive. This sets a levy on products with a high carbon footprint imported into the EU, effectively extending the EU ETS to all importers from the aforementioned energy-intensive regions.
Each year the EU sets a cap on the amount of CO2 emissions to be reduced each year, and companies must have a European Emission Allowance (EUA) for each tonne of CO2 they emit in a given calendar year. If a company emits more CO2 than its emission allowances cover, it faces a fine.
Revenue from the EU ETS goes mainly to Member States' budgets or to the EU-wide Innovation Fund and Modernisation Fund. In 2023, the EU ETS generated a total of €43.5 billion in auctioning revenues, €4.7 billion more than in 2022.
In total, the scheme has helped reduce emissions from the sectors covered by it by around 47% between 2005 and 2023. Figures for 2023 show a record reduction of 15.5% compared to 2022 levels, mainly due to an increase in the share of renewables. The EU ETS is the oldest of the 36 emissions trading schemes operating in the world today.
From 2027, the new emissions trading system will also cover the distribution of fuels for road transport, buildings and other industries. ETS II will initially operate alongside the original system, but it is planned to merge them in early 2030.
RGGI reigns supreme in the USA
The situation in the United States, the world's largest economy, is different. No national system analogous to the EU ETS has yet been introduced (despite repeated efforts by democratic administrations). Instead, the Regional Greenhouse Gas Initiative (RGGI), the first mandatory emissions trading system in the US, has been in place since 2009. It currently covers eleven states in the Midwest and Northeast of the United States: Connecticut, Delaware, Maine, Maryland, Massachusetts, New Hampshire, New Jersey, New York, Rhode Island, Vermont and Pennsylvania.
The goal of RGGI is the same as that of the EU ETS - to reduce CO2 emissions. The original cap for the 2009-2013 period was set above actual emissions and despite a downward revision of the cap by 45% in 2014, the system had minimal impact as a direct driver of CO2 reductions. Other factors such as the introduction of state renewable portfolio standards or the shift from coal to gas due to market conditions have probably had a greater impact. It can be concluded, however, that RGGI has affected the revenues of energy producers, to the benefit of those using low-carbon sources. From 2020, the cap - similar to the EU ETS - decreases linearly, leading to a 30% reduction from 2020 to 2030. RGGI has also met other important objectives, such as creating a stable source of revenue for participating countries (through auctioning of allowances and minimum allowance prices) and improving air quality.
In addition, the US still has a special emissions trading system in California. Its task is also to keep covered emissions below a predetermined limit despite low allowance prices. The California system's emissions cap has been set to decrease by 5% per year until 2030 and then by a factor calculated according to a formula set out in the cap-and-trade regulation until 2050.
China - the largest ETS market
China only became a significant contributor to global CO2 emissions at the turn of the century. China's emissions trading scheme, launched in 2021, is similar to the European EU ETS. Both systems use market principles to regulate emissions, setting limits on allowable emissions and allowing trading of emission allowances between companies.
The Chinese ETS is the largest system of its kind in the world in terms of the amount of emissions covered. It covers more than 40% of the country's total carbon emissions and in the first phase focuses on the energy sector, especially power plants. Future expansion to other industries such as steel, cement and chemicals is planned.
Key differences in setting emission limits:
EU ETS: In the European Union, emission allowances are allocated on the basis of a fixed cap, which is reduced annually. This cap is fixed and designed to reduce emissions over time. The system is structured as a cap-and-trade, which means that the maximum amount of emissions allowed is clearly limited.
China's ETS: Unlike the EU, China does not yet operate on a strict cap-and-trade basis. Emission allowances are distributed on the basis of emission intensity (i.e. the amount of emissions per unit of production, e.g. tonnes of CO2 per megawatt-hour). This means that companies are allocated allowances according to how much energy they produce. This approach is more flexible and does not necessarily lead to a reduction in absolute emissions, but rather to an optimisation of efficiency.
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