EU carbon market

The European Union’s Emissions Trading System (EU ETS) was established in 2005 and includes over 11.000 installations across the European Economic Area, covering around 40% of Europe’s greenhouse gas (GHG) emissions. The EU ETS is a “cap and trade” system, meaning that a cap determines the total amount of greenhouse gases that companies can emit. Under the annually shrinking cap, companies receive or buy emission allowances which they can trade as needed.

Since the beginning, the EU ETS has suffered from a surplus of emission allowances which has led to a price too low to spur a climate-friendly transformation.

The main causes for the insufficient price signal have been an unambitious overall target, the 2008 economic crisis, and the inflow of international credits. The coronavirus pandemic and ensued economic slowdown initially caused another price crash after a couple of years of prices around 25 euros.

The EU ETS Market Stability Reserve (MSR) absorbs excess allowances off the market and has helped to deal with the past surplus. However, as the pandemic has shown, the MSR is currently not fit for purpose to deal with sudden shocks or future surplus.

The EU ETS will be revised starting in 2021 as part of the EU Green Deal. Carbon Market Watch calls for a steeper emission reduction path and strengthening of the market stability reserve.

In the meantime, EU governments can help strengthen the system by cancelling surplus allowances as power plants are closed down. Furthermore, implementing either national or regional carbon floor prices is an ideal measure to strengthen the EU ETS and provide the necessary incentives to phase out coal.