European Union Emissions Trading System (EU ETS)

The European Union Emissions Trading System (EU ETS) is the EU's main carbon-pricing instrument and the largest carbon market in the world by value. It works on a cap-and-trade principle: a ceiling is set on the total greenhouse gas (GHG) emissions allowed from the sectors it covers, and companies trade emission allowances within that limit.

Launched in 2005, the system has gone through several phases. The current Phase 4 runs from 2021 to 2030 and was reinforced by the Fit for 55 package, which raised the EU ETS sectors' 2030 reduction target to 62% below 2005 levels.

How the EU ETS works

• Cap: Each year the EU sets a declining ceiling on total emissions for the regulated sectors. The cap falls by a fixed percentage annually (the linear reduction factor), so the carbon budget shrinks over time.
• Allowances (EUAs): Companies surrender one EU Allowance for every tonne of CO2 equivalent they emit. Allowances are auctioned or, in some exposed sectors, allocated for free.
• Trading: Installations that cut emissions below their holdings can sell surplus allowances; those that exceed them must buy more. This puts a single carbon price on the market.
• Market Stability Reserve (MSR): Operating since 2019, it removes surplus allowances from circulation to support the price and reduce volatility.

Sectors covered

• Power and heat generation.
• Energy-intensive industry (steel, cement, refineries, chemicals, paper, glass).
• Aviation within the European Economic Area.
• Maritime transport: shipping has been inside the EU ETS since 2024, phased in for large vessels, with methane and nitrous oxide added from 2026.

ETS2: buildings and road transport

A separate, parallel system known as ETS2 will cover fuel combustion in buildings, road transport and small industry. Allowance surrendering is scheduled to start in 2028 (the launch was postponed by one year from the original 2027 date). A Social Climate Fund will channel revenue to vulnerable households and micro-enterprises to cushion the cost.

Carbon price

The EU ETS carbon price is set by the market and fluctuates. In the first half of 2026 it traded in the region of 70 to 85 euros per tonne of CO2. The price is a key signal that makes low-carbon technologies more competitive relative to fossil fuels.

Carbon leakage and CBAM

To prevent carbon leakage (production moving to regions with weaker climate rules), exposed industrial sectors receive a share of free allowances. These are being phased out and replaced by the Carbon Border Adjustment Mechanism (CBAM), whose definitive regime, with financial obligations on importers of products such as steel, cement, aluminium, fertilisers, electricity and hydrogen, applies from January 2026.

Strengths and criticisms

• Cost-effectiveness: emissions are cut where it is cheapest to do so.
• Innovation signal: a rising carbon price rewards investment in clean technology and energy efficiency.
• Price volatility: the carbon price can swing sharply, complicating investment planning.
• Free allocation: generous free allowances have at times weakened the incentive to decarbonise, which the CBAM phase-out aims to correct.

The EU ETS is a cornerstone of EU climate policy and a reference point for emissions markets worldwide, including those in China, the United Kingdom and California. Its effectiveness rests on a tightening cap that keeps the bloc on track with the Paris Agreement. At Manglai we help companies measure their carbon footprint and prepare their sustainability reporting and carbon-pricing exposure. Discover how Manglai can help you.