The EU emissions trading system (EU ETS) is a cornerstone of the European Union's policy to combat climate change and its key tool for reducing industrial greenhouse gas emissions cost-effectively. It was launched in 2005 and is now in its third phase, running from 2013 to 2030. The EU ETS works on the 'cap and trade' principle. A 'cap', or limit, is set on the total amount of certain greenhouse gases that can be emitted by the factories, power plants and other installations in the system. The cap is reduced over time so that total emissions fall.
By putting a price on carbon and thereby giving a financial value to each ton of emissions saved, the EU ETS has placed climate change on the agenda of company boards and their financial departments across Europe. A sufficiently high carbon price also promotes investment in clean, low-carbon technologies.
However, there has been a growing surplus of allowances, largely because of the economic crisis, which has depressed emissions more than anticipated. In the short term this surplus risks undermining the orderly functioning of the carbon market; in the longer term it could affect the ability of the EU ETS to meet more demanding emission reduction targets cost-effectively. The Commission has therefore taken the initiative to postpone (or 'back-load') the auctioning of some allowances as an immediate first step.
In addition, the Commission has put forward a legislative proposal to establish a market stability reserve at the beginning of the next trading period in 2021.
Efforts to address the market imbalance would also be helped by a faster reduction in the EU ETS cap. To achieve the target of a 40% reduction in EU greenhouse gas emissions below 1990 levels by 2030, the cap will need to be lowered by 2.2% per year from 2021, compared with 1.74% currently.