The world's first and largest carbon market, running since 2005 and covering around 40% of the EU's greenhouse gas emissions. A shrinking cap, a credible price, and a second system — ETS2 — that extends carbon pricing to buildings and road transport from 2028.
Rather than tell each power plant or factory how to cut its emissions, the EU sets a ceiling on the total tonnes the covered sectors may emit in a year, then lets companies trade allowances to stay under it at the lowest overall cost. One allowance — a European Union Allowance, or EUA — carries the right to emit a tonne of CO₂-equivalent, and each year a covered site must surrender enough allowances to match its verified emissions.
The cheapest reductions happen first, while the cap still fixes how much pollution is allowed in total. Allowances reach the market by auction — now the default, with power generators buying almost all they use — or for free to industries exposed to carbon leakage, against efficiency benchmarks only the cleanest plants fully meet.
Because the cap is cut a little more each year under the Linear Reduction Factor, allowances grow scarcer and the price tends to climb. The Market Stability Reserve absorbs surplus automatically, while free allocation winds down as the Carbon Border Adjustment Mechanism (CBAM) takes over.
The main system (ETS1) covers about 40% of the EU's emissions across roughly 10,000 installations and operators. The new ETS2 picks up the home heating and motor fuel the main system doesn't reach.
A tightening cap, an automatic supply valve, deep secondary trading, and a border mechanism replacing free allocation — the moving parts that set where the EUA price goes next.
A single EU-wide ceiling falling 4.3% a year (4.4% from 2028) under the Linear Reduction Factor — far steeper than Phase 3's 1.74%. Less supply, year after year, to 2030.
An automatic valve that withholds 24% of the surplus from auctions whenever the TNAC tops 1,096 million. About 190 million allowances move into the reserve in 2026–27, down from 276 million.
The Total Number of Allowances in Circulation, published each May, drives every MSR move. The 2025 figure of ~1.02 billion fell below the trigger for the first time — surplus turning to scarcity.
The European Energy Exchange (EEX) runs the shared auction platform for most member states, with separate aviation sales. Revenue flows to governments for climate and energy spending.
The EUA December futures contract is the benchmark, traded mostly on ICE Endex, with spot, futures and options on EEX. Compliance buyers trade alongside banks and funds, adding liquidity.
Free allowances phase out as the Carbon Border Adjustment Mechanism prices the carbon in imported steel, cement, aluminium, fertilisers, electricity and hydrogen — raising real carbon bills for industry.
Where you stand under EU ETS I & II, what it costs, and which levers reduce the bill — mapped by the team.
TerraNova delivers finance-grade EU ETS intelligence for compliance buyers, CFOs and Group Sustainability Officers — from emissions tracking and CBAM exposure through allowance budgeting and ETS2 readiness.
Track verified emissions against surrender obligations at facility and corporate level, aligned to the monitor–verify–report–surrender cycle and the 30 September deadline.
Model the wind-down of free allowances against the CBAM phase-in — see how much of your emissions shift from free to purchased, and what that does to your real carbon bill.
Multi-year cost forecasts integrating the 4.3–4.4% LRF, one-off cap cuts, MSR withdrawals and a €60–95 price band — built for budgeting and hedging decisions.
Track the May TNAC release, MSR intake, EEX auction calendars, secondary-market moves and Commission policy — cross-referenced with UK ETS, WCI and other compliance markets.
Best-fit abatement projects with dynamic marginal abatement cost curves that integrate the EUA price trajectory across near (1–3yr), medium (3–7yr) and long (7+yr) horizons.
Five-year compliance forecasts integrating the EUA price trajectory, the decline of free allocation behind CBAM, and annual surrender obligations.
Prepare for carbon pricing on buildings, road transport and small industry — monitoring obligations, the 2027 auction start, the ~€45 soft ceiling and Social Climate Fund interactions.
A three-part deep dive into how Europe's carbon market works, how it got here, and where it stands today — from our compliance markets team.
A plain-English primer on cap-and-trade mechanics, coverage, allowances, the compliance cycle, the MSR and ETS2.
Two decades across four trading phases — the crashes and recoveries, backloading, the MSR, and the Fit for 55 overhaul.
Where it stands today: the 1.19bn cap, the 4.3% LRF, EEX auctions, the secondary market, the MSR and the looming ETS2 launch.
Answers to the most common questions about the EU Emissions Trading System, ETS2, and how the carbon market works.
The EU Emissions Trading System is the world's first and largest cap-and-trade carbon market, running since 2005 across 30 countries (the 27 EU members plus Iceland, Liechtenstein and Norway). It sets a shrinking ceiling on covered sectors' emissions and lets companies trade allowances (EUAs) to meet it at the lowest overall cost, covering about 40% of the EU's greenhouse gas emissions across roughly 10,000 installations and operators.
ETS1 is the main, existing system covering power and heat, heavy industry, intra-EEA aviation and maritime, with a 2030 target of 62% below 2005 levels. ETS2 is a separate new system covering the CO₂ from burning fuel in buildings, road transport and small industry, with a 42% target by 2030. ETS2 monitoring began in 2025; following a one-year postponement it becomes fully operational in 2028, with early auctions from January 2027 and the first surrender due 31 May 2029.
Since 2013 the cap has been a single EU-wide number that falls each year by a fixed share of a historical baseline — the Linear Reduction Factor (LRF). The 2023 Fit for 55 reform raised the LRF to 4.3% a year for 2024–2027 and 4.4% from 2028, with one-off cuts of 90 million allowances in 2024 and 27 million in 2026. The 2026 cap is roughly 1.19 billion allowances for power, industry and shipping, plus about 25 million for aviation.
The MSR is an automatic supply valve running since 2019. It reacts to the Total Number of Allowances in Circulation (TNAC), published each May. When the TNAC is above 1,096 million, 24% of the surplus is withheld from auctions; below 833 million, 100 million allowances are released back. For September 2026 to August 2027 the reserve will take in about 190 million allowances, down from 276 million, as the surplus shrinks toward 1.02 billion.
Free allowances given to carbon-leakage-exposed industries are being phased out as the Carbon Border Adjustment Mechanism (CBAM) phases in. CBAM puts a carbon price on imports of goods such as steel, cement, aluminium, fertilisers, electricity and hydrogen, so importers pay roughly what EU producers pay. As CBAM ramps up through the late 2020s, EU industries must buy a growing share of allowances they once received free — raising their real carbon bill even if the headline EUA price is flat.
ETS2 covers the CO₂ from fuel combustion in buildings, road transport and smaller industry not reached by the main system. Monitoring started in 2025 and verification in 2026; early auctions begin in January 2027, and ETS2 becomes fully operational in 2028 — postponed one year from 2027 — with the first surrender of allowances due 31 May 2029. It has its own Market Stability Reserve and a soft price ceiling of around €45 (in 2020 money) that releases extra supply if breached, plus a Social Climate Fund to channel revenue back to affected households.
Climate Decode's TerraNova platform provides end-to-end EU ETS support: emission reporting and MRV, CBAM exposure and free-allocation phase-out modelling, multi-year allowance budgeting against the cap and LRF, MSR and TNAC market watch, decarbonisation planning with dynamic MACC analysis, and ETS2 readiness — helping compliance buyers and project developers stay ahead of a tightening market.
See how TerraNova turns the cap, the LRF, the MSR, CBAM and ETS2 into a clear carbon-cost forecast — from compliance tracking to credit strategy across Europe's carbon market.