EU Emissions Trading System

Definition

The EU Emissions Trading System (EU ETS) is a market-based approach to controlling pollution by providing economic incentives for reducing emissions of greenhouse gases. It operates on a 'cap and trade' principle where a limit (cap) is set on total emissions from specific sectors, and companies can buy and sell allowances to emit CO2. This system is a crucial tool for achieving the European Union's climate targets and plays a significant role in carbon pricing and emissions trading strategies.

5 Must Know Facts For Your Next Test

1. The EU ETS was launched in 2005 and is the world's first major carbon market, covering over 11,000 power stations and industrial plants across the EU.
2. It operates in phases, with Phase 4 starting in 2021, which includes stricter emission reduction targets and an increased annual reduction rate of allowances.
3. Companies that reduce their emissions below their allocated allowances can sell excess credits to others, creating a financial incentive for reducing emissions.
4. The system has successfully reduced emissions by about 35% since its inception while allowing for economic growth within the participating sectors.
5. The EU ETS also supports international cooperation by linking with other carbon markets, allowing for broader trading opportunities and further reductions in emissions.

Review Questions

• How does the cap-and-trade mechanism function within the EU Emissions Trading System?
  • The cap-and-trade mechanism functions by setting a cap on the total amount of greenhouse gas emissions allowed from regulated sectors. Companies are allocated a certain number of allowances that permit them to emit CO2. If they emit less than their allowance, they can sell the surplus to other companies that exceed their limits. This creates a financial incentive for companies to reduce emissions, as they can profit from selling their unused allowances.
• Evaluate the effectiveness of the EU Emissions Trading System in achieving its climate goals since its implementation.
  • The effectiveness of the EU Emissions Trading System has been demonstrated through significant reductions in greenhouse gas emissions—about 35% since its launch in 2005—while still supporting economic growth. The system has prompted companies to invest in cleaner technologies and operational efficiencies. However, challenges remain, such as fluctuating allowance prices and concerns over carbon leakage, where companies relocate to countries with less stringent regulations. Overall, it has contributed significantly towards achieving the EU's climate targets.
• Critically analyze how linking the EU ETS with other international carbon markets could enhance its overall impact on global emissions reduction efforts.
  • Linking the EU Emissions Trading System with other international carbon markets could enhance its impact by broadening the trading opportunities for carbon credits, thus increasing market liquidity and stabilizing allowance prices. This interconnectedness could encourage greater investment in emission-reducing technologies globally, as firms can access more cost-effective ways to offset their emissions. Additionally, it fosters cooperation among countries towards shared climate goals. However, careful management is essential to ensure environmental integrity and prevent issues like excessive reliance on cheaper credits from less regulated markets, which could undermine global efforts to effectively combat climate change.

Related terms

Cap and Trade: A system where a government sets a limit on emissions and allows companies to buy and sell permits to emit a certain amount of pollution.

Carbon Credits: Permits that represent the right to emit one ton of carbon dioxide or equivalent greenhouse gases, which can be traded in carbon markets.

Greenhouse Gas Emissions: Gases that trap heat in the atmosphere, contributing to climate change; major ones include CO2, methane (CH4), and nitrous oxide (N2O).