European Union Emissions Trading System (EU ETS)

Definition

The European Union Emissions Trading System (EU ETS) is a market-based approach to controlling greenhouse gas emissions by providing economic incentives for reducing pollution. It operates on a 'cap-and-trade' principle, where the EU sets a limit on emissions for various sectors and allows companies to buy and sell emission allowances, thus promoting cost-effective reductions in overall emissions.

5 Must Know Facts For Your Next Test

1. The EU ETS was launched in 2005 and is the world's first major carbon market, covering around 40% of the EU's greenhouse gas emissions.
2. Emission allowances are distributed through auctions or allocated for free based on historical emissions, promoting fairness in the transition to a low-carbon economy.
3. The system has undergone several phases, with stricter caps and more ambitious targets for emissions reductions in each phase.
4. Companies that exceed their allowances must purchase additional credits or face penalties, creating a financial incentive to innovate and reduce emissions.
5. The EU ETS has contributed to significant reductions in greenhouse gas emissions in the EU, proving effective as a model for other regions considering similar trading schemes.

Review Questions

• How does the cap-and-trade mechanism of the EU ETS encourage companies to reduce their emissions?
  • The cap-and-trade mechanism sets a limit on total greenhouse gas emissions while allowing companies to trade emission allowances. If a company reduces its emissions below its allocated allowance, it can sell its excess allowances to other companies that may need them. This creates a financial incentive for companies to lower their emissions, as they can benefit economically by selling surplus allowances while also helping to meet the overall cap imposed by the EU.
• Evaluate the effectiveness of the EU ETS in achieving its environmental goals compared to other international environmental agreements.
  • The EU ETS has been effective in achieving significant reductions in greenhouse gas emissions within the EU, particularly when compared to other international agreements that may lack enforceability. The system’s market-based approach allows for flexibility and cost-efficiency in how reductions are achieved. However, it faces challenges such as fluctuations in carbon prices and overallocation of allowances in earlier phases, which have hindered its potential impact. In comparison, other agreements like the Paris Accord rely more on nationally determined contributions without a trading framework, which can make compliance less economically driven.
• Assess the long-term implications of the EU ETS on global environmental policy and business practices.
  • The long-term implications of the EU ETS are significant for both global environmental policy and business practices. As one of the first large-scale carbon markets, it serves as a model for similar systems worldwide, promoting the adoption of market-based solutions to combat climate change. Additionally, it encourages businesses to integrate sustainability into their core operations, influencing investment decisions towards cleaner technologies and practices. However, as more regions develop their own trading systems or similar policies, consistency and coordination will be crucial to avoid market fragmentation and ensure effective global emission reductions.

Related terms

Cap-and-Trade: A system that caps total greenhouse gas emissions and allows companies with low emissions to sell their extra allowances to larger emitters.

Carbon Market: A marketplace where carbon credits are bought and sold, facilitating the trading of emission allowances and incentivizing reductions in greenhouse gas emissions.

Greenhouse Gas Protocol: An international accounting tool for government and business leaders to understand, quantify, and manage greenhouse gas emissions.