The EU Emissions Trading System (EU ETS): A Market-Based Approach to Fighting Climate Change

The European Union Emissions Trading System (EU ETS), as an innovative mechanism to address climate change, has attracted much attention since its establishment. This system uses market mechanisms to encourage companies to reduce greenhouse gas emissions, covering major European emission industries, and has become an important tool to promote Europe to achieve emission reduction goals. Today I will take you to understand what EU TES is.

1. The origin of the EU Emissions Trading System (EU ETS)

As the problem of global climate warming becomes increasingly serious, the international community has begun to seek effective means of reducing emissions to address this challenge. In order to fulfill its international climate agreement, the European Union decided to establish an innovative mechanism to promote member states to achieve emission reduction goals. This mechanism is the Carbon Emissions Trading System (The EU Emissions Trading System, EU-ETS), which uses market mechanisms to incentivize Businesses reduce greenhouse gas emissions. Greenhouse gases included in the EU carbon emission system include carbon dioxide (CO2), nitrous oxide (N2O) and perfluorinated compounds (PFCs). In June 2023, the European Parliament and EU Council member states formally adopted EU ETS-related proposals, and EU ETS has become a regulation.

EU-ETS is a carbon trading mechanism based on EU laws and national legislation. It has always been the largest, most mature carbon emissions trading market with the most participating countries in the world. In terms of market size, according to Refinitiv’s assessment of global carbon trading volumes and carbon prices, the carbon trading volume of the EU carbon trading system has reached approximately 169 billion euros, accounting for 87% of the global carbon market share. In terms of emission reduction effects, as of 2019, EU carbon emissions have decreased by 23% compared to 1990.

2. European carbon emission reduction progress and goals

According to the European Parliament’s EU ETS amendment, the EU plans to reduce greenhouse gas emissions by 62% in 2030 compared with 2005, from 3.67 billion tons to 1.39 billion tons. Under European Climate Law, the EU plans to become carbon neutral by 2050.

In 2020, Europe’s carbon emissions were 3.62 billion tons, a decrease of 33.7% from 1990; the EU’s carbon emissions were 2.57 billion tons, a decrease of 31.6% from 1990. In 2020, EU ETS emissions fell sharply by 13.3% due to the impact of the epidemic and high carbon prices, driven by electricity emissions reductions, 11.2% emissions from the power and industrial sectors, and 64% decline from the aviation industry.

3. EU ETS coverage

The EU Carbon Emissions Trading System covers the main emitting industries in Europe: power generation and heating, energy-intensive industrial sectors including refineries, steel mills, and iron, aluminum, other metals, cement, lime, glass, ceramics, pulp, paper , paperboard, acids and bulk organic chemicals, aluminum products, nitric acid, adipic acid and glyoxylic acids and glyoxal, as well as maritime and commercial aviation for more than 10,000 energy industry and manufacturing facilities. The EU Emissions Trading System covers approximately 45% of EU member states’ greenhouse gas emissions.

4. EU ETS operating mechanism

The core trading principle of EU-ETS is the total volume control trading principle (Cap and Trade). It can be distinguished into two modes:

The first model is a decentralized decision-making model covering the first two trading phases (2005-2012). The total target is mainly set through the development of national allocation plans by each member state and approval by the European Commission.

The second model is the centralized decision-making model implemented since 2013. The national allocation plan is cancelled, and the European Commission directly sets a total target covering the EU.

The EU-ETS distribution mechanism is mainly a mixture of free distribution and auction, and the proportion of the auction part is increasing year by year. Each EU member state designates an auctioneer. Any quota auction must be conducted through the auctioneer. Bidders can submit prices within the window period, and investment institutions can also participate in the bidding. Revenues from allowance auctions go to the EU and member state governments and are used for emission reduction projects and the development of renewable energy.

The EU ETS emissions trading system is implemented through a series of steps and mechanisms, aiming to promote the reduction of carbon emissions through market mechanisms. The implementation of the system mainly includes the following aspects:

01. Quota allocation and acquisition: At the beginning of each stage, the EU will allocate carbon emission quotas to participating companies based on the carbon emission intensity benchmark value of each industry. These quotas represent the amount of carbon dioxide that companies are allowed to emit.

02. Allowance trading: If a company’s actual carbon emissions are lower than its quota, it can sell the excess quota on the carbon market to other companies that need additional quotas. Conversely, if a company’s carbon emissions exceed its allowance, it must purchase additional allowances to cover its excess emissions.

03. Violation penalties: If companies fail to submit their carbon emissions reports on time or fail to purchase enough allowances to cover their emissions, they will face severe financial penalties. This ensures that businesses comply with EU ETS regulations.

5. Impact on Chinese enterprises and application measures

Shipping industry: At present, China has become the world’s largest shipbuilding country and marine equipment producer, as well as the largest ship-owning country. The EU’s tax on ship carbon emissions is an opportunity for the green transformation of my country’s shipbuilding and shipping industries. For Chinese ships entering the EU routes, if the shipping company fails to pay the carbon quota in full and on time, in addition to paying the corresponding carbon quota, it will face a fine of 100 euros per ton of carbon quota. Measures for energy conservation and emission reduction can be summarized as: energy efficiency improvement, sustainable fuel application and scientific operation management. Among them, in terms of sustainable fuels, in addition to LNG in the transition period, the application of green hydrogen, green ammonia, and green methanol on ships is the key to the shipping industry achieving net-zero emissions in 2050.

Aluminum industry: my country is a major producer and exporter of aluminum products, and the EU is an important overseas market. According to a research report released by the Green Innovation and Development Center, under the influence of EU carbon tariffs, the cost of aluminum per ton will increase by 4,295-4,909 yuan.

Steel industry: Facing the continued advancement of the EU’s deep emission reduction policy, China’s steel industry will face tremendous pressures such as increased production costs and weakened international competitiveness.

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