EU ETS

The EU Emissions Trading System (EU ETS) is the EU's system for trading greenhouse gas emission allowances, set up by the ETS Directive (Directive 2003/87/EC). Installations, aircraft operators and shipping companies in its scope must surrender one allowance for each tonne of CO₂ equivalent (CO₂e) they emitted the year before. The law caps the number of allowances issued each year and lowers it every year.

The EU ETS is mandatory for the businesses it covers. It reaches them through national law: the ETS Directive is addressed to EU countries, which must put its rules into their own laws. No covered installation may operate without a greenhouse gas emissions permit, and a business that doesn't surrender enough allowances pays a penalty.

How does the EU ETS work?

Each allowance lets its holder emit one tonne of CO₂e. Since 2021, the share of allowances that EU countries auction has been 57%. Allowances that aren't auctioned are allocated free of charge under harmonised rules and benchmarks, placed in the market stability reserve or cancelled. Electricity production gets no free allocation, with a few exceptions. Allowances can be transferred between persons in the EU, and those issued since 1 January 2013 stay valid indefinitely.

Operators of installations and aircraft operators follow the same yearly cycle:

• They monitor and report their emissions for each calendar year.
• Their reports are verified; an operator or aircraft operator whose report isn't verified as satisfactory by 31 March can't transfer allowances until it is.
• By 30 June, the competent authorities issue that year's free allocation to installations.
• By 30 September, they surrender allowances equal to their verified emissions of the previous year.

Shipping companies report their emissions and have them verified under the maritime monitoring rules, and they surrender by the same 30 September deadline.

Our explainer on the yearly compliance cycle takes each step in turn, and the one on free allocation explains who gets free allowances and how many.

Where does the EU ETS stand now?

The ETS Directive has been in force since 25 October 2003. It was reformed in 2023 by Directive (EU) 2023/958 on aviation and Directive (EU) 2023/959, which entered into force on 5 June 2023, with some provisions of Directive (EU) 2023/959 following on 1 January 2024.

Three changes take effect in 2026:

• For their 2026 emissions onwards, shipping companies surrender allowances for 100% of their verified emissions, after 40% for 2024 and 70% for 2025.
• Aircraft operators get no more free allowances, apart from reserved quantities.
• Free allocation for goods covered by the Carbon Border Adjustment Mechanism (CBAM) starts to shrink.

Three Commission proposals would change the system. They are proposals, not law:

• COM(2026) 616 of 17 July 2026, a review of the Directive and of the market stability reserve.
• COM(2026) 619 of 17 July 2026, on revised benchmark values for the heat and fuel benchmarks from 2026 to 2030.
• COM(2026) 153 of 1 April 2026, to stop invalidating allowances in the market stability reserve.

Our Decode on what the July 2026 review would change sorts the review proposal by who it affects and from when.

How is the cap set, and what does the market stability reserve do?

The cap is the Union-wide quantity of allowances, and it falls by a linear factor each year: 4.3% from 2024 to 2027 and 4.4% from 2028. On top of that, the quantity was cut by 90 million allowances in 2024 and by 27 million in 2026.

The market stability reserve adjusts the number of allowances auctioned to the total number of allowances in circulation, which the Commission publishes by 1 June each year. Above 1,096 million, 12% of that total is deducted from the auctions of the 12 months from 1 September and placed in the reserve, a rate doubled until 31 December 2030. Between 833 million and 1,096 million, the amount above 833 million goes in. Below 400 million, 100 million allowances are released from the reserve and auctioned.

Since 2023, allowances held in the reserve above 400 million are no longer valid. The Commission says 3.2 billion allowances had been invalidated by the end of 2024, and it has proposed to stop the invalidation.

Where does the money from auctions go?

EU countries decide how to use their auction revenues, but they must spend them, or the equivalent in financial value, on purposes the Directive lists. These include cutting emissions, renewable energy and grids, energy efficiency, decarbonising transport, support for lower- and middle-income households, and climate action in vulnerable non-EU countries.

Part of the allowances funds two EU-level funds. The Modernisation Fund supports energy systems and energy efficiency in EU countries whose gross domestic product (GDP) per head is below set levels. The Innovation Fund supports low- and zero-carbon techniques, processes and technologies in the sectors the Directive covers.

How are CBAM and the EU ETS linked?

CBAM complements the EU ETS by applying an equivalent set of rules to imports of the goods it covers. The CBAM Regulation says CBAM is to replace the EU ETS mechanisms against the risk of carbon leakage, by reflecting how far EU ETS allowances are allocated free of charge. The two are tied in three ways.

First, free allocation for goods covered by CBAM is phased out. The Directive applies a CBAM factor: free allocation is 97.5% of the full amount in 2026, 95% in 2027, 90% in 2028, 77.5% in 2029, 51.5% in 2030, 39% in 2031, 26.5% in 2032 and 14% in 2033. From 2034, no CBAM factor applies, so those goods get no free allocation. Commission proposal COM(2026) 616 would slow this down, to 91.5% in 2028 and 0% only from 2038; that is a proposal, not law.

Second, the CBAM certificates importers buy are priced at the weekly average of the closing prices of EU ETS allowances at auction; for emissions declared for 2026, the quarterly average applies. The certificates they owe are adjusted to reflect the free allocation EU producers of the same goods receive.

Third, the CBAM penalty for missing certificates is the EU ETS excess emissions penalty. Our CBAM hub covers CBAM itself, and our explainer on what a CBAM certificate costs works through the price of a CBAM certificate.

Is ETS2 postponed to 2028?

Yes. Regulation (EU) 2026/667, in force since 7 April 2026, postpones emissions trading for buildings, road transport and additional sectors, which the Commission calls EU ETS2, until 2028. ETS2 is a separate system in Chapter IVa of the Directive, with its own activities listed in Annex III; this page covers the original EU ETS.

What happens if a business doesn't comply?

A business that hasn't surrendered enough allowances by 30 September pays an excess emissions penalty of €100 for each tonne of CO₂e not covered, and still has to surrender the missing allowances. For allowances issued since 1 January 2013, the penalty rises with the European index of consumer prices. The Directive doesn't state today's indexed amount, so we don't give one here.

EU countries publish the names of operators, aircraft operators and shipping companies that don't surrender enough allowances. A shipping company that fails to surrender for two or more reporting periods in a row, where other enforcement measures have failed, can be refused entry to EU ports. An aircraft operator can face an operating ban decided by the Commission at an EU country's request.

The EU ETS applies to the activities listed in Annex I of the Directive and the greenhouse gases listed in Annex II. Three groups carry the obligation to surrender allowances: operators of installations, aircraft operators and shipping companies.

Which installations are covered?

An installation is covered if it carries out an Annex I activity above that activity's threshold:

• Burning fuels with a total rated thermal input above 20 MW; units under 3 MW don't count towards the total
• Production activities above a capacity threshold, such as iron or steel above 2.5 tonnes per hour, cement clinker in rotary kilns above 500 tonnes per day, glass above 20 tonnes per day and hydrogen above 5 tonnes per day
• Some activities without a capacity threshold, such as the production of ammonia, primary aluminium and nitric acid

Once any threshold is exceeded, every unit burning fuels in the installation goes into the permit, except units incinerating hazardous or municipal waste.

These installations are not covered:

• Installations used for research, development and testing of new products and processes
• Installations where burning biomass that meets the sustainability criteria made up on average more than 95% of emissions over the preceding five-year period

An EU country can also exclude small installations:

• Installations that emitted less than 25,000 tonnes of CO₂e, and for combustion had a rated thermal input below 35 MW, in each of the three preceding years, if measures with an equivalent effect apply to them
• Installations that emitted less than 2,500 tonnes of CO₂e in each of the three preceding years
• Reserve or backup units that ran no more than 300 hours a year in each of the three preceding years

Our explainer on whether the EU ETS applies to an installation walks through the thresholds and exclusions.

Are waste incinerators covered?

Since 1 January 2024, installations incinerating municipal waste with a total rated thermal input above 20 MW are covered only for monitoring, reporting and verification of their emissions, under Articles 14 and 15. Commission proposal COM(2026) 616 would phase in an obligation to surrender allowances for them from 2031 to 2034; it is a proposal, not law. The installations explainer covers today's rules.

Which shipping companies are covered?

The EU ETS covers the maritime transport activities of Regulation (EU) 2015/757, the maritime monitoring rules, with some exceptions. That means ships of 5,000 gross tonnage and above carrying cargo or passengers for commercial purposes, on voyages to and from ports in EU countries and within those ports. Smaller general cargo and offshore ships, from 400 gross tonnage, report under the monitoring rules but aren't in the EU ETS; offshore ships of 5,000 gross tonnage and above are excluded until 31 December 2026.

A shipping company is the shipowner, or the organisation such as the manager or bareboat charterer that has taken over responsibility for operating the ship. It counts these emissions:

• 50% of the emissions on voyages between a port of call in an EU country and one outside the EU
• 100% of the emissions on voyages between ports of call in EU countries
• 100% of the emissions within ports of call in EU countries

The share it must surrender rose in steps: 40% of verified emissions for 2024, 70% for 2025 and 100% for 2026 and every year after. The EU ETS covers carbon dioxide from ships, and methane and nitrous oxide since 1 January 2026. Until 31 December 2030, ice-class ships may surrender 5% fewer allowances, and some island, public service and outermost-region routes are or can be exempted.

When another business buys the fuel or decides the cargo carried or the ship's route and speed under a contract, the shipping company is entitled to be reimbursed by it for the cost of the allowances. The shipping company stays responsible for surrendering them. Our shipping explainer covers what this means for shipping companies and their customers.

Which flights are covered?

The EU ETS covers flights departing from or arriving at an aerodrome in an EU country. Exclusions include aircraft with a maximum take-off mass below 5,700 kg, military flights, and commercial operators with fewer than 243 flights per period for three consecutive four-month periods or with annual emissions below 10,000 tonnes. From 1 January 2026, the allowances that aircraft operators used to get free are auctioned, except reserved quantities.

Under the law in force, aircraft operators don't have to surrender allowances for flights to and from aerodromes outside the European Economic Area (EEA), except flights to the United Kingdom or Switzerland, from 1 January 2021 to 31 December 2026. Commission proposal COM(2026) 616 would continue this derogation for 2027 and 2028, also excepting flights to and from Gibraltar; it is a proposal, not law. Open question, in our reading: if the proposal isn't adopted by 1 January 2027, the law in force applies from that date, and the proposal's text doesn't say how its 2027 and 2028 derogation would apply once that date has passed.

What about businesses the EU ETS doesn't cover?

A business carries obligations under the original EU ETS only if it operates an installation, aircraft or ships in its scope. Other businesses meet it indirectly. When a business buys a ship's fuel, or decides the cargo carried or the ship's route and speed under a contract, the shipping company is entitled to be reimbursed by it for the cost of surrendering allowances. Importers of goods covered by CBAM buy certificates priced at EU ETS auction prices. Our CBAM hub sets out which importers have to buy them.

Does the EU ETS apply in Norway, Iceland, Liechtenstein and Switzerland?

Norway, Iceland and Liechtenstein apply it through the EEA Agreement, and the Commission counts them as ETS countries next to the 27 EU countries. EEA Joint Committee Decision No 335/2023 brought the 2023 reform, Directive (EU) 2023/959, into the EEA Agreement from 31 December 2023, and requires these countries to set excess emissions penalties equivalent to those in EU countries. Switzerland has its own emissions trading system, linked to the EU ETS by an agreement in force since 1 January 2020.