The EU Emissions Trading System ETS In A Nutshell

2nd March 2026

The European Union Emissions Trading System (EU ETS) is the EU’s flagship carbon pricing mechanism. Introduced in 2005, it was the world’s first international carbon market and remains one of the largest globally. At its core, the EU ETS requires polluters to pay for their greenhouse gas (GHG) emissions. By putting a price on carbon, it helps drive emissions reductions while generating funding to support the transition to a low-carbon economy.

The system currently covers emissions from:

• Electricity and heat generation
• Energy-intensive industrial manufacturing
• Aviation
• Maritime transport (included from 2024)

Together, these sectors account for around 40% of the EU’s total greenhouse gas emissions. The EU ETS operates across all EU Member States, as well as Iceland, Liechtenstein and Norway. Since 2020, it has also been linked to the Swiss Emissions Trading System.

How Does the EU ETS Work?

The EU ETS operates on a “cap and trade” principle.

The Cap

A limit (or 'cap') is set on the total amount of greenhouse gases that installations and operators covered by the system can emit. This cap is reduced every year in line with the EU's climate targets, ensuring that overall emissions decline over time. Since its launch, the system has delivered substantial results. By 2023, emissions from power generation and industrial plants covered by the EU ETS had fallen by approximately 47% compared to 2005 levels.

Emission Allowances

The cap is divided into emission allowances. Each allowance gives the holder the right to emit one tonne of CO₂ equivalent (CO₂e). Allowances are primarily sold through auctions, although some sectors receive a limited number of free allocations. Companies can also buy and sell allowances between themselves, depending on their operational needs. If a company reduces its emissions, it may:

• Sell surplus allowances, or

• Retain them for future use

All transactions are recorded in the EU’s Union Registry to ensure transparency and compliance. Companies must monitor and report their emissions annually and surrender enough allowances to cover their verified emissions. Failure to comply results in significant financial penalties.

Carbon Pricing and Market Dynamics

The price of allowances is determined by supply and demand in the EU carbon market, which operates under strict regulatory oversight. As the cap declines over time, allowances become scarcer, reinforcing their market value. This creates a financial incentive for companies to reduce emissions in the most cost-effective way. Since 2013, the EU ETS has generated more than €175 billion in revenue.

How Is the Revenue Used?

Most EU ETS revenue flows to Member States’ national budgets. Governments are required to use these funds to support:

• Renewable energy development
• Energy efficiency improvements
• Low-carbon technologies
• Industrial decarbonisation

In addition, dedicated funds — such as the Innovation Fund and the Modernisation Fund, use ETS revenues to support breakthrough clean technologies and help modernise energy systems across Europe.

In summary, the EU ETS is a market-based mechanism that limits emissions, puts a price on carbon, incentivises decarbonisation and funds the EU’s green transition.

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