Companies in the sectors covered by the EU’s Emissions Trading System (EU ETS) -power, heavy industry, aviation and shipping- are required to purchase pollution permits to cover their emissions through auctions. Our latest FAQ has the answers to everything you always wanted to know about the EU ETS revenues.
Companies in the sectors covered by the EU ETS (power, heavy industry, aviation and shipping) are required to purchase pollution permits to cover their emissions through auctions. Auctioning is the most transparent method for allocating these emission allowances and puts into practice the principle that the polluter should pay. The auctioning of allowances is organised by the European Energy Exchange (EEX), with the revenues going directly to the 30 countries covered by the EU ETS according to a predefined division key.
One allowance represents a tonne of greenhouse gas emissions. Installations covered by the EU ETS are obliged to hand over allowances equal to their emissions of the previous year. For example, an installation that emitted 1 million tonnes of CO2 in 2023 would need to transfer 1 million allowances to the European Commission’s central registry in 2024.
Between 2021 and 2030, a little over half of the total amount of general allowances will be auctioned. The remainder is allocated to companies for free: sectors deemed to be at risk of carbon leakage, the aviation sector, and electricity producers in some lower-income member states receive free allocations.
Operators that need more allowances can also buy them on the open (or so-called secondary) market: there are several trading platforms where ETS operators (or others such as financial institutions) can trade allowances with each other. Transfers of allowances can also be included in other contracts, such as for the purchase of heat or electricity.
Since the 2023 reform came into effect, member states have to spend EU ETS revenues on climate-related activities pursuant to Article 10 (3) of the EU ETS Directive (with the exception of money used to pay indirect carbon costs to some energy-intensive producers).
Climate-related activities are defined as any activities aimed at reducing emissions, avoiding deforestation, fostering renewables and related infrastructure, energy efficiency, scaling up cleaner technologies for mobility and heating, as well as deploying carbon capture and storage and carbon removals, not to mention protecting vulnerable households affected by increased costs of electricity.
Previously, member states had been investing less than three-quarters of EU ETS revenue in climate-related activities in the 2013-2021 period, with €25 billion not spent on climate action, and another €12 billion spent on projects that were either not sensible in climate terms or that could have resulted in increased emissions. The reporting system also makes it possible for member states to simply cover existing climate spending with EU ETS revenue.
It’s worth mentioning that the European Commission tabled a proposal in June 2023 to designate 30% of EU ETS revenues to the EU budget (so-called “own resources”). This proposal has yet to be approved by the co-legislators.
The remaining EU ETS revenue is currently split between EU funding mechanisms supporting the financing of clean technology and the energy transition.
The Innovation Fund is a funding mechanism that supports the scaling up of innovative clean technology through grants and auctions. It is expected to raise over €57 billion between 2021 and 2030. This is to be invested in technologies related to the decarbonisation of heavy industries, the harnessing of renewable energy sources and infrastructure, carbon capture and storage, sustainable mobility and buildings.
The Modernisation Fund supports 13 lower-income member states with their energy transition. In 2021-2030, the fund is expected to raise and invest €69.5 billion.
Starting from 2026, a small portion of the revenues of the original ETS (power, industry, aviation and shipping) will fund the Social Climate Fund (SCF), with the majority of funding coming from the ETS for road transport and buildings and from member state contributions.
The free allocation system was originally developed to shield operators from the risk of so-called “carbon leakage”, the situation arising when a company moves its production from a country/region with stringent climate requirements to a location with looser emissions constraints, resulting in higher overall pollution.
Although scant evidence exists of carbon leakage, these freebies undermine the polluter pays principle and deprive state coffers of billions of euros that could be invested in climate action and a just transition.
Since 2013, the power sector has overall had to purchase the entirety of its ETS allowances.
However, heavy industries deemed at risk of carbon leakage by the European Commission receive most of their allowances for free. The free allocation system is set to be phased out fully in 2034, with a gradual reduction of allowances distributed for free until then.
Aviation companies currently still receive some allowances for free, but the phase-out of free allocation for aviation will be completed in 2026.
Shipping companies, which came under the EU ETS starting in 2024, pay their carbon price in full (with a short phase-in period: 40% of shipping CO2 emissions will be covered by the ETS in 2024, 70% in 2025, and 100% in 2026).
Historically, the volume of allowances distributed for free to heavy industry far exceeded the amount of emissions that were reported, leading to over-allocation that often resulted in windfall profits for the benefitting companies (especially in the steel, cement, and petrochemical sectors).
While the first years of the EU ETS saw an almost negligible price for carbon (averaging less than €10/tonne CO2 until late 2017) with the introduction of the Market Stability Reserve a stark increase in price translated into a growing market value of allowances allocated for free. In the 2013-2020 trading period, over 4,3bln allowances were distributed for free, to cover 4,1bln EUAs to be surrendered by industrial operators – a net overallocation of 200 million allowances, while the default allocation method should have been auctioning. Over-allocation to industrial sectors is foreseen to peak in 2025, slightly decreasing afterwards.
