Emissions Trading System
IntermediateAn emissions trading system (ETS) is a market-based approach to reducing pollution in which a government sets a cap on total emissions and issues allowances that companies can buy and sell, each permitting a set amount of emissions.
Emissions trading systems are also called cap-and-trade schemes. The government sets a limit on total emissions from covered sectors and issues allowances up to that limit, either for free or by auction. Companies must hold enough allowances to cover their emissions. Those that cut emissions cheaply can sell spare allowances to those that find it more expensive.
Over time, the cap is lowered, reducing total emissions and usually raising the price of allowances.
The European Union Emissions Trading System, launched in 2005, is one of the world’s largest and covers power generation, heavy industry and aviation within Europe, and has expanded to shipping. China launched a national emissions trading system in 2021, initially covering the power sector, making it the largest by emissions covered. Other systems operate in the United Kingdom, California, South Korea and elsewhere.
For example, a power company that switches from coal to renewables might sell its unused allowances to a cement maker. An ETS gives certainty about the total amount of emissions, while the price varies with demand.
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