According to the European Commission, the EU Emissions Trading System (ETS) works on the principle of “cap-and-trade”. It sets an absolute limit or ‘cap’ on the total amount of certain greenhouse gases that can be emitted each year by the entities covered by the system. Regulated entities buy or receive emissions allowances, which they can trade with another as needed.
At the end of each year, regulated entities must surrender enough allowances to cover all of their emissions. If a regulated entity reduces its emissions, it can keep the “saved” allowances to cover its future needs or sell them to another installation that is short of allowances. The ultimate goal is that this cap is reduced over time so that total emissions fall.
Even though this system was created in 2005, 2021 has been a particular year for this market since prices of carbon have risen more than 140%, indirectly also increasing the cost of polluting. This situation is mainly explained by two factors.
The first one is due to stricter EU climate goals. Europe’s trading scheme is expected to play a key role in the EU’s ambitious target of achieving net emission reductions of at least 55% by 2030, compared to 1990 levels. The European Commission mentions that the sectors currently covered by the EU ETS account for around 41% of the EU’s total emissions, so their contribution is crucial to achieving the overall target.
The second factor is the recent increase in gas prices in the last couple of months. The rise of global gas prices led some electricity generators to switch to more polluting coal-fired power, ramping up demand for carbon permits. It is considered that the rally in natural gas prices made dirtier coal more economic to use for power generation.
Initially, the idea is that making it expensive to pollute will push dirty fuels out of the power generation and industrial processes. According to some articles, that’s not really happening. Soaring natural gas prices mean Europe will likely see emissions increase this year as coal plants burn profitably through the winter.
Additionally, there are some at-risk industries that have claimed that escalating carbon prices could ultimately damage their efforts to invest in new technologies, thereby delaying a much-needed industry shift away from fossil fuels.
Even though the ETS Market is under a regulatory framework, this scenario could give an idea for Voluntary Carbon Markets and the several interests that there are behind the different agents that are in the carbon market. The current outcomes of this system show that there is still a lack of right incentives and regulations to promote a transition that is more consistent over time. Additionally, it is important to avoid other situations like leakage in which these emissions will be located in other regions that do not have this regulatory framework, which shows that this is not only a topic of concern in Europe but globally.