The EU Emissions Trading System (EU ETS) is a carbon market that puts a price on greenhouse gas emissions from large industrial facilities, power stations and airlines across Europe. It works on a “cap and trade” principle: the EU sets a limit (cap) on the total amount of emissions allowed, and companies must hold permits (called allowances) for every tonne of CO2 they emit. If they emit less, they can sell their spare allowances. If they emit more, they must buy extra.
Think of it like a ticket system for pollution. There are only so many tickets in circulation, and the number shrinks every year. Companies that clean up their act have tickets to spare and can sell them for profit. Companies that keep polluting have to buy more tickets at increasing prices. Over time, the shrinking supply makes emitting more expensive and clean alternatives more attractive.
Launched in 2005, the EU ETS is the world’s first and largest carbon market. By 2023, it had helped reduce emissions from covered sectors by approximately 47% compared to 2005 levels. It operates across all EU member states plus Iceland, Liechtenstein and Norway, and Northern Ireland for electricity generation.
⚙️ How Does the EU ETS Work in Practice?
📉 The Cap
The cap is the total number of allowances issued across the system in a given year. Each allowance gives the right to emit one tonne of CO2 equivalent. The cap decreases annually – currently by 4.3% per year (2024-2027), increasing to 4.4% from 2028. This reduction rate is designed to deliver a 62% cut in ETS emissions by 2030 compared to 2005 levels.
💰 Allowance Distribution
Allowances reach companies in two main ways. The majority (around 57% of the cap) are sold through auctions, with the revenue going primarily to EU member state governments. Ireland, along with other member states, must use all ETS auction revenue for climate action and energy transformation. The remainder of allowances are given to certain industrial sectors for free – a measure designed to prevent “carbon leakage,” where companies move production outside the EU to avoid carbon costs.
Free allocation is being phased down over time and made conditional on companies taking decarbonisation action. For the aviation sector, free allocation will be completely removed from 2026.
📊 Trading
Companies can trade allowances on the EU carbon market. If a company reduces emissions below its allocation, it can sell the surplus to another company that needs more. This creates a financial incentive for the cheapest emission reductions to happen first – wherever in the system it is most cost-effective to cut.
The price of allowances fluctuates based on supply and demand. After years of low prices that blunted the system’s effectiveness, reforms have driven the carbon price significantly higher in recent years – giving companies a much stronger incentive to invest in clean technology.
🔍 Compliance
Every year, companies must monitor and report their emissions, have them verified by an independent auditor, and surrender enough allowances to cover their total output. If they fail to comply, heavy financial penalties apply. The EPA administers the EU ETS in Ireland for both stationary installations and aircraft operators.
🏭 What Does the EU ETS Cover?
The original EU ETS (now sometimes called ETS1) covers emissions from:
- 🌿 Power generation: Electricity and heat from power stations and combined heat and power plants
- 🌿 Energy-intensive industry: Cement, lime, steel, aluminium, glass, ceramics, pulp, paper, chemicals, oil refining and other manufacturing
- 🌿 Aviation: Flights within the European Economic Area and departing to Switzerland and the UK
- 🌿 Maritime transport: Shipping emissions added from 2024, covering voyages between EU ports and 50% of voyages to/from non-EU ports
In Ireland, ETS-covered installations include gas-fired power stations, the cement sector, pharmaceutical plants, food and drink manufacturing facilities and other large energy users. These are the “stationary ETS” emissions that sit outside the Effort Sharing Regulation targets that cover the rest of the economy.
🆕 ETS2: The New System for Transport and Buildings
A second emissions trading system, called ETS2, is being introduced to cover sectors not included in the original ETS – specifically road transport, buildings, and smaller industrial sources. Unlike ETS1, which regulates large installations directly, ETS2 operates “upstream” by regulating fuel suppliers rather than end consumers.
Monitoring and reporting began in January 2025, and ETS2 is due to become fully operational in 2027 (though this was delayed to 2028 under political pressure over energy affordability concerns). Fuel suppliers will need to surrender allowances to cover the emissions from the fuels they sell. The cost will ultimately be reflected in fuel prices, creating a market incentive for consumers and businesses to reduce fossil fuel use.
A Social Climate Fund has been established alongside ETS2 to support vulnerable households and small businesses through the transition – recognising that rising fuel costs from carbon pricing can disproportionately affect lower-income groups. This connects directly to energy poverty concerns in Ireland.
🇮🇪 What Does the EU ETS Mean for Ireland?
The EU ETS has two main implications for Ireland.
First, it directly regulates emissions from Ireland’s largest industrial emitters and power generators. These companies face a real financial cost for every tonne of CO2 they produce, incentivising investment in cleaner technology. The ETS is separate from Ireland’s domestic carbon tax, which applies to fossil fuels in sectors not covered by the trading system (homes, transport, small businesses, agriculture). Large installations covered by the ETS are generally exempt from the domestic carbon tax to avoid double taxation.
Second, the distinction between ETS and non-ETS emissions matters for Ireland’s climate targets. Under the EU Effort Sharing Regulation, Ireland must reduce its non-ETS emissions by 42% by 2030 compared to 2005 levels. Non-ETS emissions include transport, residential heating, agriculture, small businesses and waste – exactly the sectors where Ireland is struggling most. The ETS sectors (electricity, large industry) are regulated at EU level through the cap, so Ireland’s national targets focus on everything else.
Understanding this split is important when reading Irish climate data. When the EPA reports that “energy industries” emissions dropped by 21.6% in a single year (as happened in 2023), much of that reduction occurred in ETS-covered power stations. Those gains do not count toward Ireland’s Effort Sharing targets – they are captured within the EU-wide ETS cap instead.
🔗 How the Emissions Trading System Connects to Other Climate Terms
- 🌿 Carbon budgets – Ireland’s national carbon budgets cover all emissions economy-wide, but sectoral ceilings distinguish between ETS and non-ETS sectors
- 🌿 MtCO2eq – each ETS allowance represents the right to emit one tonne of CO2 equivalent
- 🌿 Carbon capture – CCS can reduce the emissions a facility must surrender allowances for, improving its position under the ETS
- 🌿 Energy poverty – ETS2 could increase fuel costs for households, which is why the Social Climate Fund was created
- 🌿 Scope 1, 2 and 3 emissions – ETS covers many Scope 1 (direct) emissions from large facilities and Scope 2 (electricity) emissions indirectly through the power sector
- 🌿 Renewable energy – the ETS makes fossil fuel electricity more expensive, improving the competitiveness of wind, solar and other renewables
❓ Frequently Asked Questions
Is the EU ETS the same as Ireland’s carbon tax?
No. They are separate systems. The EU ETS is a cap-and-trade market that regulates large industrial emitters and power stations across Europe. Ireland’s carbon tax (currently €71 per tonne of CO2 on petrol and diesel) applies to fossil fuels used in sectors not covered by the ETS – homes, transport, small businesses and agriculture. Large ETS installations are generally exempt from the domestic carbon tax to avoid being charged twice for the same emissions.
Does the EU ETS affect my energy bills?
Indirectly, yes. Power generators must buy allowances to cover the CO2 from burning natural gas, which increases the cost of producing electricity. This cost is passed through to wholesale electricity prices, which feeds into what you pay as a consumer. As the carbon price rises and the cap tightens, this effect increases – but so does the incentive for generators to switch to renewable energy, which carries no carbon cost.
What is carbon leakage?
Carbon leakage occurs when companies move production to countries with weaker climate policies to avoid carbon costs, resulting in no net reduction in global emissions. The EU addresses this by giving free allowances to industries most at risk of leakage and through the Carbon Border Adjustment Mechanism (CBAM), which applies carbon costs to certain imported goods from outside the EU.
How does ETS2 affect homeowners and drivers?
From 2027/2028, fuel suppliers will need to buy allowances for the CO2 embedded in the petrol, diesel, gas and heating oil they sell. This cost will likely be passed on to consumers through fuel prices. The effect will be similar to a carbon tax increase – making fossil fuels more expensive and strengthening the case for retrofitting your home, switching to a heat pump, or driving an electric vehicle. The Social Climate Fund aims to protect vulnerable households from the cost impact.