HW3 | ETS: Energy Trading System

The EU Emissions Trading System (EU ETS) is one of the European Union’s main policy instruments aimed at combating climate change and reducing greenhouse gas emissions. As one of the largest carbon markets in the world, the EU ETS was established to promote the reduction of greenhouse gas emissions such as carbon dioxide by EU member states and companies through market mechanisms. The operation of this system involves a complex interaction between governments, businesses and regulators, and the following details about the definition of the EU ETS, how it works and its importance in global climate governance.

1. EU Emissions Trading System (EU ETS)

The EU ETS was launched in 2005 to reduce greenhouse gas emissions from industry and the energy sector across the EU through economic incentives and market mechanisms. The system covers about 11,000 companies in a wide range of industries, including power, steel, cement and petrochemicals, and accounts for more than half of the EU’s total emissions. The EU ETS is one of the key instruments for the European Union to achieve the objectives of the Kyoto Protocol and the Paris Agreement.

2. How the EU Emissions Trading System works

The core mechanisms of the EU Emissions Trading System are “emission permits” and “carbon markets”. Its operation can be summarized as follows:

(a). Allocation of emission permits: The EU divides total emissions into a certain number of emission permits (also known as emission allowances or emission rights), which are allocated to companies participating in the system. These emissions permits are usually issued in a fixed number each year and can vary depending on the size of the company and the characteristics of the industry.

(b). Carbon market trading: Companies can trade emissions permits on the carbon market. If companies emit less than the number of emissions permits they hold, they can sell the excess permits to other companies. Conversely, if companies emit more than the number of permits they hold, they need to buy additional permits to make up the difference.

(c). Emission reduction and innovation incentives: Because buying additional emissions permits increases costs, the EU ETS provides incentives for companies to reduce carbon emissions and adopt cleaner, greener production methods. This market mechanism drives technological innovation and the energy transition by facilitating the formation of carbon pricing and carbon markets.

3. The importance of the EU Emissions Trading System

(a). An important component of global climate governance: As one of the world’s largest carbon markets, the EU ETS is of great significance for global climate governance. It not only provides an effective tool for EU member states to achieve their carbon reduction targets, but also provides a reference for other countries.

(b) Promote carbon pricing and carbon market development: The establishment and operation of EU ETS has promoted the development of carbon pricing and carbon market mechanisms. Regulate carbon prices through market supply and demand mechanisms to incentivize companies to reduce carbon emissions and adopt cleaner production technologies.

(c) Promoting sustainable development and the transition to a green economy: EU ETS encourages companies to adopt more environmentally friendly production methods, contributing to sustainable development and the transition to a green economy. It provides financial incentives for businesses to invest in low-carbon technologies and innovation.

References and sources of information

1.Carbon Market Watch. (2022). EU ETS 101:  A Guide to the European Union Emissions Trading System. Retrieved from https://carbonmarketwatch.org/wp-content/uploads/2022/03/CMW_EU_ETS_101_guide.pdf

2.European Commission. (n.d.). EU Emissions Trading System (EU ETS). Retrieved from https://ec.europa.eu/clima/policies/ets_en

3.World Bank. (2021). State and Trends of Carbon Pricing 2021. Washington, DC:  World Bank. Retrieved from https://openknowledge.worldbank.org/handle/10986/35899

This article is a part of the class

“751447 SEM IN CUR ECON PROB”

supervised by

Asst. Prof. Napon Hongsakulvasu

Faculty of Economics,

Chiang Mai University

This article was written by Lu Liu 631615511