A greenhouse gas (or GHG for short) is any gas in the atmosphere which absorbs and re-emits heat, and thereby keeps the planet's atmosphere warmer than it otherwise would be

The EU emissions trading system (EU ETS) is a cornerstone of the EU's policy to combat climate change and its key tool for reducing greenhouse gas emissions cost-effectively. It is the world's first major carbon market and remains the biggest one.

The EU ETS works on the 'cap and trade' principle.

A cap is set on the total amount of certain greenhouse gases that can be emitted by installations covered by the system. The cap is reduced over time so that total emissions fall.

Within the cap, companies receive or buy emission allowances which they can trade with one another as needed. They can also buy limited amounts of international credits from emission-saving projects around the world. The limit on the total number of allowances available ensures that they have a value.

After each year a company must surrender enough allowances to cover all its emissions, otherwise heavy fines are imposed. If a company reduces its emissions, it can keep the spare allowances to cover its future needs or else sell them to another company that is short of allowances.

Trading brings flexibility that ensures emissions are cut where it costs least to do so. A robust carbon price also promotes investment in clean, low-carbon technologies.

The EU ETS is now in its third phase – significantly different from phases 1 and 2.

The main changes are:

A single, EU-wide cap on emissions applies in place of the previous system of national caps

Auctioning is the default method for allocating allowances (instead of free allocation), and harmonised allocation rules apply to the allowances still given away for free

More sectors and gases included 300 million allowances set aside in the New Entrants Reserve to fund the deployment of innovative renewable energy technologies and carbon capture and storage through the NER 300 programme

The system covers the following sectors and gases with the focus on emissions that can be measured, reported and verified with a high level of accuracy:

  • carbon dioxide (CO2) from
    • power and heat generation
    • energy-intensive industry sectors including oil refineries, steel works and production of iron, aluminium, metals, cement, lime, glass, ceramics, pulp, paper, cardboard, acids and bulk organic chemicals
    • commercial aviation
  • nitrous oxide (N2O) from production of nitric, adipic and glyoxylic acids and glyoxal
  • perfluorocarbons (PFCs) from aluminium production

Participation in the EU ETS is mandatory for companies in these sectors, but

  • in some sectors only plants above a certain size are included
  • certain small installations can be excluded if governments put in place fiscal or other measures that will cut their emissions by an equivalent amount
  • in the aviation sector, until 2016 the EU ETS applies only to flights between airports located in the European Economic Area (EEA).

The EU ETS has proved that putting a price on carbon and trading in it can work. Emissions from installations in the scheme are falling as intended – by around 5% compared to the beginning of phase 3 (2013) (see 2015 figures).

In 2020, emissions from sectors covered by the system will be 21% lower than in 2005.

In 2030, under the Commission's proposal, they would be 43% lower.

Set up in 2005, the EU ETS is the world's first and biggest international emissions trading system, accounting for over three-quarters of international carbon trading.

The EU ETS is also inspiring the development of emissions trading in other countries and regions. The EU aims to link the EU ETS with other compatible systems.

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