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The EU Emissions Trading System (EU ETS 1) operates on a market economy basis to reduce emissions of climate-damaging gases in Europe. Politically defined limits contribute to determining the price of greenhouse gas emissions on the market. In this way, emissions trading provides a catalyst for investments that promote climate-friendly technologies.
Source: frentusha_istock
Our explanatory film shows how emissions trading works and focuses with specific emphasis on its characteristics in the European Emissions Trading System 1 (EU ETS 1) (as of 2020).
The European Emissions Trading System 1 (EU ETS 1) was introduced in Europe as a result of the Kyoto International Agreement on Climate Change. At Kyoto in 1997, the participating parties agreed for the first time on internationally binding stabilisation and reduction targets for greenhouse gas emissions in industrialised countries.
In December 2015, at the UN Climate Conference in Paris, the ‘Paris Climate Agreement’ was adopted, in which the participating countries agreed to take further measures to limit global warming to well below 2 degrees Celsius.
With regard to the scope of EU ETS 1, this translates to a reduction of 62 percent compared to emission levels in 2005. The changes in EU ETS 1 also include a faster reduction in the annual Emissions cap, increasing by 4.3 percent per year, and rising to 4.4 percent from 2028 onwards instead of the previous 2.2 percent, as well as changes to the Market Stability Reserve (MSR) to limit excesses. In addition, the European Carbon Border Adjustment Mechanism (CBAM) was introduced as part of the ‘Fit for 55’ package.
Other measures include
• the inclusion of maritime transport in EU ETS 1 from 2024,
• adapting the scope for aviation in EU ETS 1, and
• the inclusion of the buildings, transport and additional sectors in emissions trading (EU ETS 2)
Detailed information on the reform of European Emissions Trading System can be found here.
The EU ETS is also an important financial instrument for climate investment. 100 percent of the proceeds will be used in an active economic and social support for the transformation to climate neutrality. In Germany, the proceeds flow into the Climate Transformation Fund (KTF), which promotes climate protection projects, the expansion of renewable energies and the decarbonisation of industry.
21/02/2024
For example:
Emissions trading works according to the ’cap and trade’ principle. The government-set cap determines the maximum amount of CO2 equivalents in total that may be emitted by regulated companies. A cap that is ambitious in terms of climate policy ensures that CO2 becomes a scarce commodity and that a price for CO2 is formed on the market through trade, which gives companies an incentive to invest in more climate protection. After all, if it is more cost-efficient to avoid one tonne of CO2eq than to buy an allowance, it is worth taking technical measures to reduce emissions.
Unlike rigid legal stipulations, which lead to varying levels of costs for the companies concerned, a market-based instrument such as emissions trading gives companies room to take their own decisions. They can decide for themselves whether they want to reduce emissions or buy additional allowances. This approach also yields economic advantages because the avoidance of emissions is mainly implemented by those companies that have the lowest avoidance costs.
From a climate policy point of view, another advantage of emissions trading is that the establishment of a fixed maximum (cap) means the amount of emissions permissible at a certain point in time cannot exceed predetermined levels. To sum up, emissions trading is essentially characterised by the fact that it can achieve set environmental targets safely and at the most favourable economic costs. In addition, the revenues from emissions trading generate considerable financial leeway for active economic and socio-political support of the transformation to climate neutrality. However, other instruments such as regulatory law or funding policies have their own advantages. In practice, therefore, a mix of instruments is used.
All companies participating in emissions trading must surrender an allowance for each tonne of CO2eq emitted. Tradable allowances can be issued either in the form of a free allocation or by auctioning on the primary market (sale or auction). The auctioning of allowances is generally preferable as it takes into account the polluter-pays principle and the state generates revenues that can be used for climate protection measures. A limited number of allowances will be made available to some of the companies free of charge in accordance with the allocation rules defined throughout Europe. As part of the ‘Fit for 55’ package, the free allocation for industries with high energy consumption will in principle remain but a part (20 percent) will now be linked to compliance with certain conditions. In addition, it will be gradually reduced for those sectors covered by the Carbon Border Adjustment Mechanism CBAM (for details, see section ‘Reform and Perspectives’). Aircraft operators will no longer receive a free allocation starting as early as 2026. This will also apply to maritime transport from 2026 onwards and to the EU ETS 2 starting in 2027.
Companies that do not receive free allowances or find their allocation insufficient must bid for allowances in the (almost) daily auctions or buy them from other market participants on the secondary market. Conversely, if they have a surplus of allowances and/or save them through emission reduction measures, they can sell them. This is where the term emissions trading comes from. Strictly speaking, it is not emissions that are traded, but rather allowances that grant permission to emit the corresponding amount of greenhouse gases. For more information, see the link under Allocation.
In addition to the European Commission, the Federal Ministry of Economic Affairs and Climate Action (BMWK), the DEHSt and the states (Länder) are also involved in implementing European emissions trading in Germany. The European Commission operates the Union Registry and reviews and approves the amount of free allocations for companies in Member States. The DEHSt issues the allowances to the stakeholders' accounts.
As the national competent authority, we are also responsible for monitoring emissions trading with all the rules and obligations for operators and aircraft operators, shipping companies, those responsible within the framework of EU ETS 2 and the management of German auctions in EU ETS 1 and much more. In the first quarter of every year we receive the companies' emissions reports, which we then review. We are subject to the legal and technical supervision of the Federal Ministry of Economic Affairs and Climate Action (BMWK).
All transactions of allowances, which only exist virtually, take place through the Union Registry. In this centralised system, all participating stakeholders have an account in which they can hold their allowances and carry out transactions such as issuance, purchases, sales, cancellations and surrenders of allowances corresponding to the emissions generated. More information on the Union Registry can be found in the link below.
The following applies to EU ETS 1: operators of stationary installations and aircraft as well as shipping companies determine their greenhouse gas emissions in the previous year by the end of March (those responsible within EU ETS 2 by 30 April). The data is first checked by nationally accredited Verifiers (e.g. TÜV and other large inspection organisations) and only then can they be forwarded to the Union Registry. Operators and shipping companies must surrender the relevant number of allowances to the Union Registry by the end of September at the latest (those responsible within EU ETS 2 by 31 May).
If insufficient allowances are surrendered, companies risk severe sanctions: a penalty of 100 euros (plus the increase in the European Consumer Price Index for the reporting year compared to the reference year 2012) must be paid for each tonne of CO2eq for which an allowance has not been surrendered. For the 2022 reporting year, the amount of the penalty is already around 121 euros. Operators and shipping companies must therefore ensure that they have a sufficient number of allowances by the specified deadlines at the latest and surrender them. If they lack allowances, they can purchase more in advance, for example on the Energy Exchanges in Leipzig (EEX) or Amsterdam (ICE Endex). Further information can be found on our sanctions website (link below).
Trading in European allowances (EU Allowances (EUa), EU Aviation Allowances (aEUA) or EUAA) takes place primarily at the trading centres in Amsterdam (ICE Endex) and Leipzig (EEX). In addition, relevant over-the-counter trading is also performed. Auctions, i.e. auctioning European allowances (EU-Allowances (EUA), EU Aviation Allowances (aEUA) or EUAA) currently take place exclusively on the EEX.
Auctions are held almost daily. This regularity ensures that the auctions are seamlessly integrated into market activity. As a result, prices realised at the auctions align with the price level in continuous exchange trading on the secondary market.
All auction results are published online within a few minutes. This serves to maximise market transparency. We regularly report on the entire market activity for the allowances in our monthly auction reports.
The auctioning reports published by DEHSt not only cover the auctions but also the much larger volume of continuous trading on the exchanges. In relation to the relevant overall allowances market, about six percent of the traded volume in 2023 could be attributed to auctions.
The adoption of an amended Emissions Trading Directive in 2018, the introduction of the Market Stability Reserve in 2019 and the expectation of more ambitious caps in the future due to the implementation of the ‘European Green Deal’ led to an upward trend in EU-Allowances (EUA) prices, which reached new highs at the beginning of 2023. However, there was a downward correction up to the beginning of 2024.
Overview of price history and allowance surpluses:
A large part of the revenue from the auctions in EU ETS 1 will be used specifically to promote decarbonisation in industry and the energy sector
The revenue from the auctions in the EU ETS 2 will be utilised via the EU Climate and Social Fund, among others.
European emissions trading (EU ETS 1 and, from 2027 on, EU ETS 2) will be implemented in all 27 EU Member States. Norway, Iceland and Liechtenstein have also joined EU ETS 1. With the exception of a few installations in Northern Ireland, the United Kingdom of Great Britain and Northern Ireland (hereinafter referred to as United Kingdom) has not participated in EU ETS 1 since the beginning of 2021 and has introduced its own emissions trading system. EU ETS 1 is linked to the emissions trading system in Switzerland.
Below you will find a brief overview of the sectors participating in EU ETS 1.
In the fourth trading period, we publish a current list of stationary installations subject to emissions trading in Germany in the middle of each year. We use the same data basis that we use for the VET report on greenhouse gas emissions from installations subject to emissions trading in Germany, which is published annually in mid-June.
Since the start of emissions trading in 2005, we have published an annual report on greenhouse gas emissions from stationary installations in Germany that are subject to emissions trading - the so-called VET report. VET ("Verified Emissions Table") refers to the verified emissions in the Union Registry, on which the evaluations in the VET report for the respective current reporting year are based. Since 2011, the report has also included a section on emissions from aviation in emissions trading.
The report provides a comprehensive overview of the German emissions of individual sectors in the stationary sector and in aviation as well as their allocation situation.