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Annex 4: The European Union Emissions Trading Scheme


Box 5: The European Union Emissions Trading Scheme (EU ETS)

The largest and most publicised carbon market is the European Union Emissions Trading Scheme (EU ETS). This works through 25 countries and covers emissions from four broad sectors:

  • production and processing of iron and steel
  • minerals (eg, cement, glass)
  • energy
  • pulp and paper (forestry is not included, the focus is on industrial emitters).

This is a cap-and-trade system (ie, an overall cap is placed on emissions and trading may occur within the cap). It covers about 45% of European Union CO2 emissions or 30% of its overall greenhouse gas emissions (CO2 emissions only are covered in the EU ETS). [Consideration is being given to including other sectors of the economy and other greenhouse gases in the EU ETS.] In total, 12,000 installations are covered in the EU ETS.

European Union Member State governments are required to set an emission cap for all installations covered by the scheme. Within this cap, each installation is allocated emission allowances for the particular commitment period in question (the EU ETS covers the 2005 to 2007 period and then the 2008 to 2012 period).

A company can purchase allowances on the EU ETS if it plans to pollute more than its allocated number of allowances would imply. Similarly, it can sell allowances if its emissions reduce. Considerable penalties apply if a firm has insufficient permits to cover its emissions. Given this, an incentive operates for polluters to invest in technologies/work practices to reduce their emissions - if the cost of reducing emissions is less than the cost of purchasing allowances then it is sensible for firms to reduce emissions (and vice versa).

For the second period of the EU ETS (2008 to 2012), there will be the ability for member states to use the Kyoto flexibility mechanisms (the CDM and JI initiatives - credits from nuclear facilities and land-use change and forestry activities are not accepted).

There is a limit on the number of emission permits allowed to enter the EU ETS through the Kyoto flexibility mechanisms. This means that much of the CO2 mitigation must occur within the European Union (and reflects a specific European Union policy decision). As a result, the price of emissions permits within the EU ETS is significantly higher than the price of emission reduction units under the Kyoto flexibility mechanisms.