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Use this function to compare the design elements and characteristics of up to three ETSs from around the world.
USA - California Cap-and-Trade Program
General Information
The California Cap-and-Trade Program began operation in 2012 with the opening of its tracking system for allocation, auction distribution, and trading of compliance instruments. Compliance obligations started in January 2013. The program covers ~75% of the state’s GHG emissions.
The program covers ~400 facilities and emissions from the power, industrial, transport, and buildings sectors. Covered entities must surrender allowances for all their covered emissions. Allowances are distributed via a combination of auction, free allocation, and free allocation with consignment. The proceeds from auctioning are reinvested in projects that reduce emissions, strengthening the economy, public health, and the environment, especially in disadvantaged communities.
The California Cap-and-Trade Program is implemented under the authority of the California Air Resources Board (CARB). California has been part of the Western Climate Initiative (WCI) since 2007 and formally linked its program with Québec’s in January 2014.
In December 2022, the Board of CARB approved the “2022 Scoping Plan for Achieving Carbon Neutrality”. The plan lays out a path of carbon neutrality that includes a 48% reduction of emissions below 1990 levels in 2030, which exceeds California’s statutory 40% reduction target. CARB announced it would evaluate all major programs, including the Cap-and-Trade Program, to assess the need to increase the stringency between now and 2030 and a Program through 2045.
A series of informal stakeholder workshops began in June to consider potential amendments to the program. CARB presented three different scenarios for revising future allowance budgets consistent with emission reductions of 40%, 48%, and 55% below 1990 levels. Among other topics considered during public workshops were updates to cost-containment mechanisms, the use of revenues from consigned allowances, and carbon leakage protection measures.
Any amendments to the Cap-and-Trade Regulation are expected to be voted on by the Board of CARB by the end of 2024, with the changes potentially implemented from 2025.
Emissions & Targets
381.3
By 2030: 40% reduction from 1990 GHG levels (SB 32)
By 2045: Carbon neutrality and 85% reduction from 1990 anthropogenic GHG levels (AB 1279)
Updated prices available here
Size & Phases
FIRST COMPLIANCE PERIOD: Two years (2013 and 2014)
SECOND COMPLIANCE PERIOD: Three years (2015 to 2017)
THIRD COMPLIANCE PERIOD: Three years (2018 to 2020)
FOURTH COMPLIANCE PERIOD: Three years (2021 to 2023)
FIFTH COMPLIANCE PERIOD: Three years (2024 to 2026)
A cap limits the total emissions allowed in the system.
FIRST COMPLIANCE PERIOD: The system started in 2013 with a cap of 162.8 MtCO2e, declining to 159.7 MtCO2e in 2014, at a rate of ~2% annually.
SECOND COMPLIANCE PERIOD: With the program expanding to include fuel distribution, the cap rose to 394.5 MtCO2e in 2015. The cap decline factor averaged 3.1% per year in the second compliance period (2015 to 2017), reaching 370.4 MtCO2e.
THIRD COMPLIANCE PERIOD: The cap in the third compliance period started at 358.3 MtCO2e and declined at an average annual rate of 3.3% to 334.2 MtCO2e in 2020.
FOURTH COMPLIANCE PERIOD AND BEYOND: During the 2021 to 2030 period, the cap declines by about 13.4 MtCO2e each year, averaging ~4% per year, to reach 200.5 MtCO2e in 2030.
The “Cap-and-Trade Regulation” sets a formula for declining caps after 2030 through 2050.
FIRST COMPLIANCE PERIOD: Covered sectors included those that have one or more of the following processes or operations: large industrial facilities (including cement, glass, hydrogen, iron and steel, lead, lime manufacturing, nitric acid, petroleum and natural gas systems, petroleum refining, and pulp and paper manufacturing, including cogeneration facilities co-owned/operated at any of these facilities); electricity generation; electricity imports; other stationary combustion; and CO2 suppliers.
SECOND COMPLIANCE PERIOD AND BEYOND: In addition to the sectors listed above, suppliers of natural gas, suppliers of reformulated blendstock for oxygenateblending (i.e., gasoline blendstock) and distillate fuel oil (i.e., diesel fuel), suppliers of liquefied petroleum gas in California, and suppliers of liquefied natural gas are covered by the program.
INCLUSION THRESHOLDS: Facilities emitting ≥25,000 tCO2e per year. All electricity imported from specified sources connected to a specific generator with emissions >25,000 tCO2e per year is covered. Emissions associated with imported electricity from unspecified sources have a zero threshold, and all imported electricity emissions are covered using a default emissions factor.
OPT-IN COVERED ENTITIES: A facility in one of the covered sectors that emits <25,000 tCO2e annually can voluntarily participate in the Program. Opt-in entities are subject to all registration, reporting, verification, compliance obligations, and enforcement applicable to covered entities.
Upstream (buildings and transport); point source (industry, in-state power generation); imported electricity at the point of first delivery onto California’s electricity grid.
~400 facilities
Allowance Allocation & Revenue
Allowances are distributed via free allocation, free allocation with consignment, and auction.
FREE ALLOCATION: Industrial facilities receive free allowances to minimize carbon leakage. For nearly all industrial facilities, the amount is determined by product-specific benchmarks, recent production volumes, a cap adjustment factor, and an assistance factor based on assessment of leakage risk.
Leakage risk is divided into “low”, “medium”, and “high” risk tiers based on levels of emissions intensity and trade exposure for each specific industrial sector.
FIRST COMPLIANCE PERIOD: The Cap-and-Trade Regulation as adopted in 2011 set assistance factors of 100% for the first compliance period, regardless of leakage risk.
SECOND COMPLIANCE PERIOD AND BEYOND: For facilities with medium leakage risk, the original regulation included an assistance factor decline to 75% for the second compliance period and to 50% for the third. For facilities with low leakage risk, it included an assistance factor decline to 50% for the second compliance period and to 30% for the third. However, amendments to the Cap-and-Trade Regulation made in 2013 delayed these assistance factor declines by one compliance period. Pursuant to AB 398 adopted in 2017, all assistance factors were changed to 100% through 2030, citing continued vulnerability to carbon leakage. There is no cap on the total amount of industrial allocation, but the formula for allocation includes a declining cap adjustment factor to gradually reduce allocation in line with the overall cap trajectory.
Free allocation is also provided for transition assistance to public wholesale water entities, legacy contract generators, universities, public service facilities, and, during the period 2018-2024, waste-to-energy facilities.
FREE ALLOCATION WITH CONSIGNMENT: Electrical distribution utilities and natural gas suppliers receive free allocation on behalf of their ratepayers. Natural gas and electric utilities must use the allowance value for ratepayer benefit and for GHG emissions reductions. All allowances allocated to investor-owned electric utilities and an annually increasing percentage of allowances allocated to natural gas suppliers must be consigned for sale at the state’s regular quarterly auctions. Publicly owned electric utilities can choose to consign freely allocated allowances to auction or use them for their own compliance needs.
AUCTIONING:
• Auction share: ~70% of total California-issued vintage 2023 allowances made available through auction in 2023, which included allowances owned by CARB (~41%) and allowances consigned to auction by utilities (~29%).
• Auction volume: 197,368,635 (2023 vintage) 25,400,000 for advance auction (2026 vintage).
Unsold allowances in past auctions are gradually released for sale at auction after two consecutive auctions are held in which the clearing price is higher than the minimum price. However, if any of these allowances remain unsold after 24 months, they will be placed into CARB’s price ceiling reserve or into the two lower reserve tiers (see ‘Market Stability Provisions’ section). To date, 37 million allowances originally designated for auction have been placed in reserves through these provisions.
USD 26.97 billion since beginning of program
USD 4.72 billion in 2023
REVENUE FROM AUCTION OF CALIFORNIA-OWNED ALLOWANCES: Most of California’s auction revenue goes to the Greenhouse Gas Reduction Fund, of which at least 35% must benefit disadvantaged and low-income communities. The funds are then distributed as California Climate Investments, which support projects that deliver significant environmental, economic, and public health benefits across the state. As of May 2023, USD 9.8 billion (of the total USD 27.0 billion revenue raised) has been invested in 569,477 projects, with expected GHG reductions of 98 MtCO2e. Over USD 7.2 billion has reached disadvantaged and low-income communities.
REVENUE FROM AUCTION OF UTILITY-OWNED ALLOWANCES: Investor-owned electric utilities and natural gas suppliers are allocated allowances, a portion of which must be consigned to auction. Auction proceeds must be used for ratepayer benefit and for GHG emissions reductions.
Flexibility & Linking
Banking is allowed, but is subject to a holding limit on allowances to which all entities in the system are held. The holding limit is based on the year’s cap and decreases annually. Entities may also be eligible for a limited exemption from the holding limit based on their emissions levels to support meeting annual compliance obligations or obligations at the end of a three-year compliance period.
Borrowing is not allowed.
The use of compliance offset credits is allowed. Such credits, issued by CARB or by the authority of a linked cap-and-trade system, are compliance instruments under the California Cap-and-Trade Program.
QUALITATIVE LIMIT: Currently, offset credits originating from projects carried out according to one of six compliance offset protocols are accepted as compliance instruments:
• US. forest projects;
• Urban forest projects;
• Livestock projects (methane management);
• Ozone-depleting substances projects;
• Mine methane capture projects; and
• Rice cultivation projects.
Compliance offset credits issued by jurisdictions linked with California (i.e., Québec) are eligible to be used to satisfy a California entity’s compliance obligation, subject to the quantitative limits described below.
To ensure environmental integrity, California’s compliance offset program has incorporated the principle of buyer liability. The state may invalidate an offset credit that is later determined not to have met the requirements of its compliance offset protocol due to double counting, over-issuance, or regulatory non-conformance. The entity that surrendered the offset credit for compliance must then substitute a valid compliance instrument for the invalidated offset credit.
QUANTITATIVE LIMIT: For 2013 to 2020 emissions, entities could meet up to 8% of their obligations using offset credits. For emissions after 2020, entities are subject to lower limits on the use of offset credits established by AB 398. The share of offsets that can be used to fulfil the compliance obligation is 4% per year for 2021 to 2025 emissions, and 6% for 2026 to 2030 emissions.
In addition to setting new quantitative limits on the use of offset credits, AB 398 set new limits on the types of offset credits that can be used to fulfil compliance obligations. Starting with compliance obligations for 2021 emissions, no more than 50% of any entity’s offset usage limit can come from offset projects that do not provide direct environmental benefits to the state (DEBS).
Projects located within California are automatically considered to provide DEBS. Offset projects implemented outside of California may still result in DEBS, based on scientific evidence and project data provided. For example, a forest project outside California has been determined to provide benefits within California by improving the quality of water flowing through the state. Recent regulatory amendments specify the criteria used to determine DEBS.
California’s program linked with Québec’s in January 2014. The two expanded their joint market by linking with Ontario in January 2018 until the termination of Ontario’s system in mid-2018.
Compliance
Except for the year following the last year of a compliance period, compliance instruments equal to 30% of the previous year’s verified emissions must be surrendered annually, by the start of November. Compliance instruments equal to all remaining emissions must be surrendered by the start of November of the year following the last year of a compliance period.
REPORTING FREQUENCY: Annually
VERIFICATION: Emissions data reports and their underlying data require annual verification by an independent third-party for all entities covered by the Program.
FRAMEWORK: Reporting is required for most emitters at or above 10,000 tCO2e per year. They must implement internal audits, quality assurance, and control systems for the reporting program and the reported data.
A covered entity that fails to surrender sufficient compliance instruments to cover its verified GHG emissions on either an annual surrender deadline or a compliance period surrender deadline is automatically assessed an untimely surrender obligation. It is required to surrender the missing compliance instruments as well as three additional compliance instruments for each compliance instrument it failed to surrender.
Failure to meet this untimely surrender obligation would subject the entity to substantial financial penalties for its noncompliance, pursuant to “California Health and Safety Code Section 38580”.
Separate and substantial penalties apply to mis-reporting or non-reporting under the “Regulation for the Mandatory Reporting of Greenhouse Gas Emissions”.
Market Regulation
MARKET PARTICIPATION: Covered entities, opt-in covered entities, and voluntarily associated entities can participate in the program. Voluntarily associated entities are approved individuals or entities that intend to:
- purchase, hold, sell, or retire compliance instruments but are not covered under the program;
- operate a compliance offset project registered with CARB; or
- provide clearing services and derivative clearing services as qualified entities.
Voluntarily associated entities must be in the United States and have an approved account in the system registry, the Compliance Instrument Tracking System Service (CITSS). Additional eligibility criteria apply, including for individual market participants.
MARKET TYPES:
Primary: Allowances are made available through sealed-bid auctions. State-owned and consigned allowances are offered through quarterly allowance auctions organized jointly with Québec. Auctions are administered by WCI, Inc.
Secondary: Allowances, offset credits, and financial derivatives are traded in the secondary market on the Intercontinental Exchange (ICE), CME group, and Nodal Exchange platforms. Any company qualified to access these platforms can trade directly or through a future commission merchant. Companies can also trade directly over the counter but must have a CITSS account to take delivery of compliance instruments.
LEGAL STATUS OF ALLOWANCES: Allowances are defined as limited tradable authorizations to emit up to one tCO2e. According to the “California Code of Regulations”, an allowance does not constitute property or bestow property rights and cannot limit the authority of the regulator to terminate or limit such authorization to emit.
Auction Reserve Price: USD 24.04 per allowance in 2024. The auction reserve price increases annually by 5% plus inflation, as measured by the Consumer Price Index.
Reserve: Some allowances from each annual cap are placed in an Allowance Price Containment Reserve (APCR). Prior to amendments mandated by AB 398, these allowances were spread across three reserve tiers in an earlier APCR. Pursuant to AB 398, from 2021 onward, these allowances have been placed into two price tiers and a price ceiling.
Specifically, AB 398 directed where allowances from the earlier APCR would be distributed. Two-thirds of those allowances were spread evenly across the two APCR price tiers. The remaining one-third (which had previously been spread evenly across the original three price tiers), plus unsold allowances that had been transferred into the APCR (about 37 million to date), have been placed into the price ceiling. In addition, the Cap-and-Trade Regulation also set aside portions of annual 2021-2030 allowance caps for the two APCR price tiers.
Although no reserve sale has been held to date, CARB will offer one if auction settlement prices from the preceding quarter are greater than or equal to 60% of the lowest APCR price tier. CARB also always offers the third quarter APCR sale before the November compliance obligation deadline.
At the price ceiling, a covered entity can purchase allowances (or, if no allowances remain, “price ceiling units”) up to the amount of its current unfulfilled emissions obligation. The revenues from the sale of price ceiling units will be used to purchase real, permanent, quantifiable, verifiable, enforceable, and additional emissions reductions on at least a tonne for tonne basis. Sales at the price ceiling will only be conducted if no allowances remain at the two lower APCR tiers and a covered entity has demonstrated that it does not have sufficient compliance instruments in its accounts for that year’s compliance event.
In 2024, the two APCR tiers and the price ceiling are set at USD 56.20, USD 72.21, and USD 88.20, respectively. Tier prices and the price ceiling increase by 5% plus inflation (as measured by the Consumer Price Index).
Other Information
California Air Resources Board: Responsible for the design and implementation of the Cap-and-Trade Program.
Western Climate Initiative, Inc.: Non-profit organization that provides cost-effective administrative and technical solutions for supporting the coordinated development and implementation of participating jurisdictions’ GHG emissions trading programs, such as administering auctions and maintaining the system registry (CITSS).
Pursuant to requirements in existing legislation (AB 32, AB 197, and AB 398), CARB must update the “California Climate Change Scoping Plan” at least every five years and must provide annual reports to various committees of the Legislature and the Board. The Scoping Plan provides updates on progress toward climate targets and lays out strategies to achieve them, including the role and level of effort accorded to different programs in the state’s portfolio approach to climate mitigation. The latest update to the Scoping Plan was adopted in December 2022.
Global Warming Solutions Act of 2006 (AB 32)
2018 amendments to the 2021-2030 period
Current regulation can be found on the CARB website
EU Emissions Trading System (EU ETS)
General Information
Operational since 2005, the European Union Emissions Trading System (EU ETS) is the oldest cap-and-trade system in force. It is a cornerstone instrument of the EU’s policy framework to combat climate change under the “European Green Deal” and reduce GHG emissions cost-effectively. Until 2023, the system covered emissions from over 10,000 installations and airlines operating in the EU. Collectively, they represent around 38% of the EU’s total emissions. From 2024, emissions from large ships are included in the EU ETS.
The EU ETS is currently in its fourth trading phase (2021 to 2030). Every year, covered entities must surrender allowances for their emissions under the EU ETS. Auctioning is the main method of distributing allowances, with free allocation, based on benchmarks, issued to address the risk of carbon leakage.
The EU ETS was revised in 2023 in the context of the European Green Deal to align the system with the 2030 climate target of at least 55% net emissions reductions compared to 1990 levels.
In the first half of 2023, the EU adopted important reforms of the EU ETS framework as part of:
- the “Fit for 55” package, to align the system with the EU’s 2030 climate target of at least 55% net emissions reductions compared to 1990 levels and the European Green Deal objectives,
- the EU’s response to the energy crisis caused by Russia’s invasion of Ukraine (“REPowerEU” plan).
These reforms:
- increased the ambition and expanded the scope of the EU ETS to maritime transport, and introduced a new, separate emissions trading system for buildings, road transport and additional sectors* (ETS 2)**;
- strengthened the Market Stability Reserve (MSR);
- updated the EU ETS regarding aviation;
- updated the rules of the monitoring and reporting of emissions from maritime transport;
- created the Social Climate Fund to complement the new ETS 2; and
- established a Carbon Border Adjustment Mechanism to address the risk of carbon leakage from specific sectors under the EU ETS (as an alternative to free allocation).
They are in force and their implementation has followed in the second half of 2023.
In May, the European Commission published the seventh communication on the MSR indicator. In addition to managing the supply of allowances to auctions, from 2023 onward the MSR cancels allowances in its holdings above a certain threshold. At the start of January 2023, 2.5 billion allowances from the MSR were cancelled.
To address the impact of the energy crisis following Russia’s invasion of Ukraine, the Commission put forward targeted reforms and investments to phase out the EU’s dependence on fossil fuel imports, ensure the security of the energy supply, promote energy efficiency, and accelerate the clean energy transition. The REPowerEU Regulation mobilizes the ETS Innovation Fund as one of the funding sources. At the same time, it directs 27 million unallocated allowances from the MSR, which would otherwise become cancelled, to replenish the Innovation Fund.
* Mainly industry sectors not covered under the existing EU ETS.
** See ETS 2 factsheet.
Emissions & Targets
3,468.3 MtCO2e (2021)
By 2030: Reduce net emissions to at least 55% below 1990 GHG levels (European Climate Law)
By 2050: Climate neutrality (European Climate Law)
EUR 83.24 (USD 90.00) (average 2023 auction price; updated prices available here)
EUR 83.47 (USD 90.25) (average secondary market price 2022)
Size & Phases
PHASE ONE: Three years (2005 to 2007)
PHASE TWO: Five years (2008 to 2012)
PHASE THREE: Eight years (2013 to 2020)
PHASE FOUR: Ten years (2021 to 2030)
A cap limits the total emissions allowed in the system It is set to bring emissions down by 2030 by 62% compared to 2005.
PHASE ONE and PHASE TWO: The cap was calculated bottom-up, based on the aggregation of the national allocation plans of each Member State. Phase 1 started with a cap of 2,096 MtCO2e in 2005; Phase 2 started with a cap of 2,049 MtCO2e in 2008.
PHASE THREE:
Installations: A single EU-wide cap was calculated based on emissions’ monitoring and set at 2,084 MtCO2e in 2013. It was reduced annually by a linear factor of 1.74% (applied to the midpoint of 2008-2012 baseline emissions). This translated into a year-on-year reduction of the cap by some 38 million allowances and resulted in a cap of 1,816 MtCO2e in 2020.
Aviation: Included in the EU ETS in 2012, with a cap calculated separately. Legally, the system covers all outgoing and incoming flights to the EEA. The 2012 cap for aviation amounted to 221 million MtCO2e (95% of 2004 to 2006 emissions). In 2013, however, the EU temporarily limited ETS obligations to flights within the EEA to support the development of a global market-based measure to reduce aviation emissions by the International Civil Aviation Organization (ICAO). The number of aviation allowances put into circulation in 2013 to 2016 was reduced to 38 million allowances annually. This ‘stop-the-clock’ limited scope of the EU ETS for aviation was extended until 2023.
PHASE FOUR:
From Phase 4, the linear reduction factor applies annually to the overall cap. The factor is set at 2.2% per year (of 2008 to 2012 baseline emissions) for the period 2021 to 2023, 4.3% for the period 2024 to 2027 and 4.4% from 2028. The cap is also reduced in two steps, by 90 million allowances in 2024 and 27 million allowances in 2026.
Installations: A single EU-wide cap subject annually to the linear reduction factor. Following the 2023 ETS revision, the cap in 2024 amounts to 1,386 MtCO2e. From 2021, the UK is no longer part of the EU ETS except for electricity generators in Northern Ireland.
Maritime: The 2024 cap has been increased by 78.4 million allowances based on the sector’s average emissions reported for 2018 and 2019.
Aviation: The aviation cap in 2024 amounts to 28.9 MtCO2e.
From Phase 4, a Member State may cancel allowances from their auction share if they take additional policy measures that result in a closure of electricity generation capacity. The quantity of allowances cancelled shall not exceed the average verified emissions of the installation from five years preceding the closure.
The EU ETS scope in terms of activities and greenhouse gases is specified in Annex I and Annex II of the “ETS Directive”.
PHASE ONE: Power stations and other combustion installations with >20 MW thermal rated input (except hazardous or municipal waste installations), industry (various thresholds) including oil refineries, coke ovens, and iron and steel plants, as well as production of cement, glass, lime, bricks, ceramics, pulp, paper, and cardboard.
PHASE TWO: Several countries included NOx emissions from the production of nitric acid. The EU ETS also expanded to include Iceland, Liechtenstein, and Norway.
Aviation: Emissions from international aviation were included in the EU ETS in 2012 (>10,000 tCO2/year for commercial aviation; >1,000 tCO2/year for non-commercial aviation since 2013). However, the EU temporarily limited the scope of the EU ETS for aviation to flights within the EEA. Exemptions for operators with low emissions were introduced.
PHASE THREE: Carbon capture and storage installations, production of petrochemicals, ammonia, nonferrous and ferrous metals, gypsum, aluminum, as well as nitric, adipic, and glyoxylic acid (various thresholds) were added to the scope.
Aviation: In 2017, the limited scope of the EU ETS for aviation was extended until 2023 to support the development of a global measure for aviation emissions under ICAO. Under the Linking Agreement between the EU and Switzerland, from 2020, the EU ETS covers emissions from outgoing flights to Switzerland.
PHASE FOUR: Amendments introduced in view of the UK’s departure from the EU and in the 2023 revision of the EU ETS.
Power and industry: The scope of ETS and benchmarks used for free allocation is broadened from 2024 to remove barriers for the deployment of new technologies such as green hydrogen or hydrogen-based steel.
Aviation: Under the “Trade and Cooperation Agreement” between the EU and the UK, the EU ETS applies to emissions from flights departing from the EEA to the UK from 2021 (the UK ETS applies to flights departing to EEA airports).
Emissions from most flights to and from the EU’s nine outermost regions as well as from departing flights from these regions to Switzerland and the UK are added to the scope from 2024.
Maritime: From 2024, emissions from all large ships (of 5,000 gross tonnage and above) entering EU ports are covered by the EU ETS, regardless of the flag they fly, covering:
- 50% of emissions from voyages starting or ending outside the EU;
- 100% of emissions that occur between two EU ports and when ships are in EU ports.
Initially, the scope extension to maritime transport concerns CO2 emissions and then CH4 and N2O emissions from 2026.
The obligation for maritime companies to surrender allowances for their emissions is being gradually phased in.
- 2025: for 40% of emissions reported in 2024;
- 2026: for 70% of emissions reported in 2025;
- 2027 onward: for 100% of emissions reported in 2026 and later years.
To ensure environmental integrity during the phase-in, Member States will cancel the number of allowances equivalent to the difference between the surrendered allowances and the verified emissions in 2024 and in 2025.
Point source
2022: 8,640 installations, 390 aircraft operators
The number of regulated shipping companies will become known throughout 2024.
Allowance Allocation & Revenue
PHASE ONE: Allocation was based on Member States’ national allocation plans. Allowances were allocated through grandparenting. Some Member States used auctioning and some used benchmark-based allocation.
PHASE TWO:
Auctioning: Eight Member States (Germany, United Kingdom, the Netherlands, Austria, Ireland, Hungary, Czechia, and Lithuania) held auctions corresponding to ~3% of the total allowance allocation.
Free allocation: ~90% of allowances were allocated for free.
PHASE THREE:
Auctioning: The main method of distributing allowances, accounting for up to 57% of the cap. Of the share of allowances to be auctioned, 88% were distributed to Member States based on verified 2005 or average 2005 to 2007 emissions; 10% were allocated between 16 lower-income Member States under the solidarity provision; and the remaining 2% were allocated between the Member States that had reduced their emissions by at least 20% compared to the applicable base year under the Kyoto Protocol.
Free allocation: A significant volume of allowances was allocated for free to address the risk of carbon leakage, based on sectors-specific performance benchmarks. As the demand for free allowances exceeded the volume of allowances available, the free allocation of each installation was subject to a uniform cross-sectoral correction factor — which was revised in 2017.
Power: Auctioning, with an optional transitional free allocation for the modernisation and diversification of electricity generation in ten lower-income Member States. At the end of Phase 3, eligible Member States could decide to continue using this option in Phase 4 (2021 to 2030), monetize remaining allowances, or transfer them to the Modernisation Fund, created under the EU ETS in 2018.
Industry: Free allocation based on sector-specific performance benchmarks, which reflect an average emissions intensity per unit of product of the most efficient 10% of installations in each sector. The European Commission established 54 benchmarks in 2011, using 2007 and 2008 activity data and literature sources (when data was missing). Sectors deemed at risk of carbon leakage received free allocation at 100% of the relevant benchmark. Sub-sectors deemed not at risk of carbon leakage had free allocation reduced gradually from 80% of the respective benchmark in 2013 to 30% by 2020.
The carbon leakage risk was assessed against emissions intensity and trade exposure:
- direct and indirect cost increase >30%; or
- non-EU trade intensity >30%; or
- direct and indirect cost increase >5% and trade intensity >10%.
Cost intensity was determined by the formula:
[Carbon price × (direct emissions × auctioning factor + electricity consumption × electricity emission factor)]/ gross value added
Trade intensity was determined by the formula:
(imports + exports)/(imports + production)
New Entrants’ Reserve (NER): 5% of the cap for Phase 3 was set aside to assist new installations or to cover installations whose capacity significantly increased since their free allocation had been determined. 300 million allowances from the reserve were allocated to the NER300, a large-scale funding program for innovative low-carbon energy demonstration projects.
Aviation: 15% of allowances were auctioned and 82% were allocated to aircraft operators for free. The remaining 3% constituted a special reserve for new entrants and fast-growing airlines. The number of allowances put into circulation for the aviation sectors was reduced to reflect the temporary limitation of the scope of the EU ETS to flights within the EEA.
PHASE FOUR:
Auctioning: the main method of distributing allowances, accounting for up to 57% of the cap. Of the share of allowances to be auctioned, 90% are distributed to Member States based on their share of verified emissions, with 10% distributed among the lower-income Member States under the solidarity provision.
Free allocation: A significant volume of allowances is allocated for free to address the risk of carbon leakage, based on sectors-specific performance benchmarks. Benchmark values are updated twice in Phase 4 to reflect technological progress in different sectors. In 2021, the European Commission updated benchmark values for the first time.* They apply in 2021 to 2025. The values are adjusted for technological progress on a yearly basis. An annual reduction rate is determined for each benchmark. For the steel sector, which faces high abatement costs and leakage risks, a fixed reduction rate applies.
The uniform cross-sectoral correction factor for the adjustment of free allocation is 1 for 2021 to 2025.
The Phase 4 cap includes a buffer of more than 450 million allowances, initially earmarked for auctioning, which can be made available if the initial free allocation volume is fully absorbed (thereby avoiding the need to apply the cross-sectoral correction factor).
Free allocation for 2026 to 2030 will become conditional on the implementation of energy efficiency measures (based on audits or energy management systems) and of carbon neutrality plans for the worst performing installations, in order to incentivize decarbonization.
Free allocation to specific sectors will be gradually phased out from 2026 to 2034, in parallel to the phase-in of EU Carbon Border Adjustment Mechanism (CBAM) for third-country imports. Those sectors are - iron and steel, cement, aluminum, fertilizers and hydrogen. The CBAM will also apply to electricity imports. The transitional, data collection phase of CBAM started on 1 October 2023, with only reporting but no charges due.
Power Sector: Auctioning, with an optional transitional free allocation for the modernization and diversification of electricity generation in ten lower-income Member States. Three of the eligible Member States decided to continue using this option in Phase 4. It can be used until the end of 2024. After this time, any leftover allowances will be either added to a Member State’s share of allowances to be auctioned or its share of the Modernisation Fund.
Industry: Updated benchmark values that apply for 2021 to 2025 were calculated based on activity data for installations over 2016 to 2017, supplied by Member States.
The updated values were compared to the original benchmarks to determine the reductions to be applied over the 15-year period between 2007/08 and 2022/23. Benchmarks could be reduced between 3% and 24% over this period. In total, 31 out of 54 benchmarks have been reduced by the maximum rate of 24%.
There are revised rules covering adjustments to free allocation when an installation makes a significant change to its production. These rules apply from Phase 4. The threshold for adjustments is a 15% increase or decrease in production. Adjustments to free allocation are issued based on yearly production data reports that operators submit to national competent authorities. Adjustments to the level of free allocation are made from the New Entrants’ Reserve.
Carbon leakage rules: The third carbon leakage list, adopted in February 2019, applies for 2021 to 2030. The list includes a reduced number of sectors classified at risk of carbon leakage. Free allocation for other sectors will be discontinued by 2030 (except for district heating).
Carbon leakage is assessed against a composite indicator of trade intensity and emissions intensity, according to the following criteria:
Trade intensity x emissions intensity > 0.2
Trade intensity x emissions intensity > 0.15 but < 0.2; qualitative assessment will follow based on abatement potential, market characteristics, and profit margins.
Emissions intensity is determined by:
[direct emissions + (electricity consumption x electricity emission factor)]/ gross value added
Trade exposure is determined by:
(imports + exports)/(imports + production)
New Entrants’ Reserve (NER): The initial volume of the NER at the start of Phase 4 amounted to 331.3 million allowances. This included unallocated allowances from Phase 3 and 200 million allowances from the MSR.
Aviation: Phase 3 breakdown applied until 2023. Free allocation to aviation will be phased out gradually – reduced to 75% in 2024, 50% in 2025 and eventually to 0% from 2026 onward.
* Revised benchmark values for free allocation of emission allowances for 2021-2025.
EUR 184 billion* (USD 206 billion) since 2013
EUR 43.6 billion** (USD 47.1 billion) in 2023
* Includes revenues from Iceland, Liechtenstein, Norway, and the UK, as well as of the Innovation and Modernisation Funds funded by the EU ETS.
** Includes revenues from Iceland, Liechtenstein, Norway, and Northern Ireland, as well as of the Innovation and Modernisation Funds funded by the EU ETS.
Revenue from the auctioning of allowances under the EU ETS accrues primarily to Member States’ budgets. Of the revenues generated until mid-2023, Member States were instructed to use at least 50% for climate- and energy-related purposes. Member States are required to use all revenues generated from that point onward to support climate and energy objectives.
Member States can use their EU ETS revenues to finance State aid to certain electricity-intensive industries to compensate for the additional electricity costs they face as a result of the EU ETS.They do so under State aid schemes that are approved by the European Commission. Every year, they must publish the total compensation amounts paid out, including a breakdown per recipient sector and subsector. The overall spending under a scheme should not exceed 25% of a Member State’s ETS revenue.
Member States report annually to the European Commission on how they spent their auction revenues. To date, Member States have reported having spent ~76% of EU ETS revenues on climate- and energy-related purposes, both domestic and international.
A share of EU ETS allowances is auctioned to supply the Innovation and Modernisation Funds – two funds established for Phase 4 to support decarbonization in the covered sectors.
Innovation Fund: Supports the commercial demonstration of innovative low-carbon technologies and industrial solutions to decarbonize Europe’s energy-intensive industries, as well as the development of renewable energy, energy storage and carbon capture use and storage.
Modernisation Fund: Supports investments in lower-income Member States aimed at modernizing energy systems, improving energy efficiency, and supporting a socially just transition to climate neutrality. It is one of the solidarity mechanisms of the EU ETS, which addresses Member States’ different starting points in the decarbonization challenge.
Flexibility & Linking
Banking is allowed (since 2008).
Borrowing is not allowed.
PHASE ONE: The use of the Clean Development Mechanism (CDM) and Joint Implementation (JI) credits was allowed without limitation. In practice, no offset credits were used in Phase 1
PHASE TWO:
The use of offset credits was allowed. 1,058 MtCO2e of international credits were used.
Qualitative limits: Most categories of CDM/JI credits were allowed, except for LULUCF and nuclear power. Strict requirements applied for large hydro projects exceeding 20 MW.
Quantitative limits: In Phase 2, operators were allowed to use JI and CDM credits up to a certain percentage limit determined in the respective country’s National Allocation Plan. Unused entitlements were transferred to Phase 3.
PHASE THREE:
The use of offset credits was allowed with strict limitations.
Qualitative limits: Newly generated international credits (post-2012) had to originate from projects in least developed countries. Credits from CDM and JI projects from other countries were eligible only if registered and implemented before the end of 2012. Projects from industrial gas credits (projects involving the destruction of HFC-23 and N2O) were excluded regardless of the host country. Credits issued for emission reductions that occurred in the first commitment period of the Kyoto Protocol were no longer accepted after March 2015.
Quantitative limits: The total use of credits for Phase 2 and Phase 3 was capped at 50% of the overall reduction under the EU ETS in that period (~1.6 Gt CO2e).
PHASE FOUR:
The use of offset credits is not allowed.
The EU ETS and the Swiss ETS have been linked since 2020. This means that allowances issued in one system can be surrendered for emissions generated in either of the two systems. The “Linking Agreement” between the EU and Switzerland sets out the conditions and requirements under which the two systems are linked. A direct link was created between the registries of both systems. It allows regulated entities to transfer allowances from an account in one system to an account in the other system.
Compliance
One calendar year.
A harmonized framework of monitoring, reporting, verification and accreditation requirements underpins the EU ETS functioning. Every year, Member States report on implementation of this framework:
- “Monitoring and Reporting Regulation (2018/2066)”
- “Accreditation and Verification Regulation (2018/2067)”
- “Monitoring and Reporting Regulation for maritime transport (2015/757)”
MONITORING: Each installation, aircraft operator and maritime transport operator is required to have an emission monitoring plan, approved by a national competent authority. The deadline for submitting an emissions report is the end of March (for the preceding calendar year).
REPORTING: Emission reports submitted annually using templates.
VERIFICATION: Emission reports are verified by independent accredited verifiers before the end of March of the following year. Once verified, operators must surrender the equivalent number of allowances by the end of September.
In addition to the detail set out here, a dedicated monitoring, reporting and verification framework for non-CO2 aviation effects is due to start from January 2025.
Regulated entities must pay an excess emissions penalty of EUR 100 (USD 108.13), adjusted for inflation, for each tCO2 emitted for which no allowance has been surrendered, in addition to buying and surrendering the equivalent number of allowances. The name of the non-compliant operator is also made public. Member States may enforce different penalties for other forms of non-compliance.
Market Regulation
MARKET PARTICIPATION: Compliance entities and non-compliance entities.
MARKET TYPES:
Primary: Uniform price auctions with single rounds and sealed bids, conducted daily by EEX. Germany has opted out of the common auctioning platform, instead running national auctions through the EEX. Poland has also opted out but continues to participate on the common auction platform at the EEX until further notice.
Secondary: Spot, futures, options, and forward contracts are traded on the secondary markets, both on exchange and over the counter. Besides the EEX, futures are traded on ICE, ENDEX and Nasdaq.
LEGAL STATUS OF ALLOWANCES:
Classified as financial instruments. The associated derivatives can hence be traded on secondary markets.
BACKLOADING: As a short-term measure implemented in Phase 3 to address a growing surplus of allowances in the EU ETS. Auctioning of 900 million allowances was postponed from the period spanning 2014 to 2016 until 2019 and 2020. The allowances were eventually placed in the Market Stability Reserve.
MARKET STABILITY RESERVE (MSR): The MSR was created in 2015 as a long-term measure to address a growing surplus of allowances in the EU ETS. It adjusts auction volumes according to pre-defined thresholds of the total number of allowances in circulation (TNAC), fostering balance in the EU carbon market and resilience to demand shocks. The MSRstarted operating in 2019.
Triggers: The Commission publishes the TNAC communication every year.
- If the TNAC is above 1,096 million, 24% of its volume is withdrawn from future auctions and placed into the MSR over a period of 12 months.
- If the TNAC is between 833 and 1,096 million, to mitigate threshold effects a smaller share of allowances is deducted from auction volumes and placed in the MSR.
- If the TNAC is less than 400 million allowances, 100 million allowances are released from the MSR and auctioned.
CANCELLATIONS: From 2023, allowances in the MSR above a certain threshold are cancelled annually. In 2023, the applicable threshold was the 2022 auction volume. From 2024, the applicable threshold is fixed at 400 million.
At the end of December 2022, the MSR contained over 3 billion allowances. The 2022 auction volume amounted to 486 million allowances. This led to a cancellation of 2,515 million allowances in January 2023.
Swiss ETS allowance supply is not considered in the TNAC, and Swiss auction quotas are not affected by the MSR.
Other Information
European Commission: Responsible for establishing the regulatory framework of the EU ETS and centralized administration of the system, e.g., the EU registry.
Competent authorities of all EU Member States as well as Iceland, Liechtenstein, and Norway: implementation, e.g., verifying compliance with MRV and surrender obligations.
The European Commission publishes annual reports on the functioning of the European carbon market (2023 report on the EU ETS functioning in 2022).
The ETS Directive stipulates that the system is kept under review in light of the implementation of the Paris Agreement and the development of carbon markets in other major economies. Three major EU ETS reviews — before Phase 3, before Phase 4, and in the context of increasing the EU 2030 climate target — have been conducted to date.
By the end July 2026, the European Commission will assess:
- how negative emissions could be accounted for and covered under the EU ETS,
- the feasibility of lowering the 20 MW total rated thermal input thresholds for the activities under the EU ETS,
- effective accounting and avoidance of double counting of CCU products under the EU ETS,
- the feasibility of including municipal waste incineration under the EU ETS,
- the functioning of the EU ETS for aviation, including the functioning of CORSIA.
By the end of December 2027, the Commission will assess the possibility of the scope of the EU ETS to include non-CO2 aviation emissions.
Directive 2003/87/EC of the European Parliament and of the Council establishing a scheme for GHG emission allowance trading within the Community and amending Council Directive 96/61/EC.
Decision concerning the establishment and operation of a market stability reserve for the Union GHG emission trading scheme and amending Directive 2003/87/EC (6 October 2015).
Consolidated Auctioning Regulation: Commission Delegated Regulation 2023/2830 supplementing Directive 2003/87/EC
All other legislation and documentation can be found here.