EU ETS, ETS2 and CBAM: Carbon Pricing in the European Union
The European Union Emissions Trading System — EU ETS — is the European Union’s main market-based instrument for reducing greenhouse gas emissions. It puts a price on carbon emissions and implements the “polluter pays” principle.
The EU ETS began operating in 2005 as the world’s first international emissions trading system. Its underlying principle is relatively straightforward: an overall emissions cap is established for the sectors covered by the system. Within this cap, operators receive or purchase emission allowances, with each allowance permitting the emission of one tonne of CO₂ equivalent. The total number of allowances decreases over time, creating an economic incentive for businesses to reduce their emissions, improve energy efficiency and invest in low-carbon technologies.
The existing system, often referred to as EU ETS1, primarily covers electricity and heat generation, energy-intensive industrial installations, aviation and maritime transport. The EU is currently in Phase IV of the EU ETS, covering the period 2021–2030. Following the reforms introduced under the “Fit for 55” package, the system was strengthened to support the EU’s more ambitious climate targets for 2030 and climate neutrality by 2050.
As an extension of this policy, ETS2 was established as a separate emissions trading system targeting emissions from fuels used in buildings, road transport and additional sectors, including parts of small-scale industry outside the existing EU ETS. ETS2 complements EU ETS1 by introducing carbon pricing in sectors that account for a significant share of energy and fuel consumption.
Alongside the EU ETS reform, the Carbon Border Adjustment Mechanism — CBAM — was introduced. Its purpose is to ensure that the carbon price paid by producers in the EU does not lead to production being relocated to countries with less stringent climate policies. This phenomenon is known as “carbon leakage”.
CBAM applies a carbon price to imports of certain carbon-intensive goods, including cement, iron and steel, aluminium, fertilisers, electricity and hydrogen. In this way, the mechanism connects EU climate policy with international trade: European producers pay for their emissions through the EU ETS, while importers of certain goods from third countries must progressively report and cover the cost of the carbon emissions embedded in the production of those goods.
How Are EU ETS1, ETS2 and CBAM Connected?
EU ETS1, ETS2 and CBAM form part of the wider climate framework established by the European Green Deal and the “Fit for 55” legislative package.
EU ETS1 puts a price on emissions from the main industrial, energy, aviation and maritime sectors.
ETS2 extends carbon pricing to buildings, road transport and additional sectors that have previously been outside the scope of the existing EU ETS.
CBAM safeguards the effectiveness of the EU ETS by reducing the risk that production within the EU will be replaced by imports of more carbon-intensive goods from third countries.
The shared objective of these instruments is to make carbon emissions economically measurable, transparent and comparable for both EU producers and importers of goods from third countries. They establish a regulatory framework in which emissions become a factor influencing competitiveness, investment and the long-term sustainability of businesses, rather than remaining an external and unaccounted-for cost.
Key Milestones
- 2005 — Launch of the EU ETS.
- 2021–2030 — Phase IV of the EU ETS.
- 2023 — Adoption of the reforms under the “Fit for 55” package.
- 2023–2025 — CBAM transitional period.
- 2025 — Start of monitoring and reporting under ETS2.
- 2026 — Start of the CBAM definitive regime.
- 2028 — ETS2 becomes fully operational.
Useful Links and Legislative Framework
1. Official European Commission Pages
EU ETS
European Commission — EU Emissions Trading System
European Commission — About the EU ETS
European Commission — EU ETS Emissions Cap
European Commission — Monitoring, Reporting and Verification
European Commission — ETS Reporting Tool
European Commission — Free Allocation
European Commission — Auctioning of Allowances
European Commission — Union Registry
ETS2
European Commission — ETS2: Buildings, Road Transport and Additional Sectors
CBAM
European Commission — Carbon Border Adjustment Mechanism
European Commission — CBAM Legislation and Guidance
European Commission — CBAM Communication and FAQs
European Commission — CBAM Sectoral Information
European Commission — CBAM Registry
European Commission — CBAM National Competent Authorities
2. Common Legal Framework for EU ETS1 and ETS2
The following legal acts apply to more than one component of the system.
Core ETS Directive
Directive 2003/87/EC — the core directive establishing the EU greenhouse gas emission allowance trading system. Following the 2023 amendments, it also contains the framework for ETS2.
Directive (EU) 2023/959 — the key amendment under the “Fit for 55” package. It strengthens the EU ETS, incorporates maritime transport and introduces the framework for ETS2.
Monitoring, Reporting, Verification and the Registry
Commission Implementing Regulation (EU) 2018/2066 — the Monitoring and Reporting Regulation, or MRR. It is the main regulation governing emissions monitoring and reporting under the EU ETS and ETS2.
Commission Implementing Regulation (EU) 2018/2067 — the Accreditation and Verification Regulation, or AVR. It governs the verification of reports and the accreditation of verification bodies.
Commission Delegated Regulation (EU) 2019/1122 — governs the operation of the Union Registry.
Market Stability and Auctioning
Decision (EU) 2015/1814 — establishes and governs the Market Stability Reserve, or MSR.
Decision (EU) 2023/136 — introduces an amendment relating to the Market Stability Reserve.
Commission Delegated Regulation (EU) 2023/2830 — sets out rules on the timing, administration and other aspects of auctioning emission allowances.
3. EU ETS1 — Key Directives, Regulations and Decisions
Main Amendments to the ETS Directive
Directive 2004/101/EC — links the EU ETS with the mechanisms established under the Kyoto Protocol.
Directive 2008/101/EC — includes aviation activities in the EU ETS.
Directive 2009/29/EC — introduces a major reform of the EU ETS for the period after 2013.
Directive (EU) 2018/410 — introduces the reform for Phase IV of the EU ETS, covering 2021–2030.
Directive (EU) 2023/958 — introduces amendments concerning aviation and the implementation of the global market-based mechanism CORSIA.
Maritime Transport
Regulation (EU) 2015/757 — governs the monitoring, reporting and verification of emissions from maritime transport.
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