carbon pricing going global

The world's biggest carbon market is getting bigger

Europe's carbon market is expanding to new sectors and cutting emissions faster.

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A crane loads a container on a cargo ship at the Total Terminal International Algeciras (TTIA) at the port of Algeciras, southern Spain.
Under a reform to the EU’s carbon market, shipping companies will need to buy carbon permits starting in 2024.
Photo: Jon Nazca (Reuters)

European Union lawmakers agreed on Dec. 18 to reform the bloc’s carbon market, expanding it to cover new sectors of the economy and increasing the pace at which it aims to drive down greenhouse gas emissions.

The EU’s “emissions trading scheme” (ETS) is the bloc’s most important climate policy. It currently covers emissions from about 10,000 power plants and industrial facilities across its 27 member states, making it the world’s biggest in terms of covered facilities—China, which has the biggest carbon market in terms of CO2 emissions, only about 2,000 power plants.

How the European Union’s ETS works

Under the EU’s ETS, these facilities are allocated a fixed number of free pollution credits and must either limit their emissions to that volume or buy more credits. The number of credits issued declines every year, and companies can sell their unused credits; these attributes both pressure companies to invest in low-carbon technologies.

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Today, the ETS covers power plants, oil refineries, and plants producing steel, aluminum, cement, paper, and organic chemicals, and other materials, and overall aims to reduce emissions in those sectors 43% below 2005 levels by 2030. Under the new plan, maritime shipping, which accounts for about 4% of EU emissions, will also be covered starting in 2024. The cap on free credit allocation will also fall more quickly, reaching zero by 2034, and covered sectors are now expected to reduce their emissions 62% below 2005 levels by 2030.

The reforms also require sellers of natural gas for building heating and gasoline for road vehicles to hold carbon permits starting in 2027. But in order to limit the impact of that policy on retail energy prices, the carbon market for buildings and vehicles will be separate from other sectors, with more free permits allocated if the price for extra permits exceeds €45 ($47.7) per ton.

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Tackling “carbon leakage”

In addition to speeding up the EU’s decarbonization, these reforms create the necessary conditions for the EU’s carbon market to reach beyond its own borders. As free permit allocations fall for EU companies, carbon permit requirements will be phased in for manufactured goods imported from outside the EU, under a border tariff plan announced last week. That way, companies wishing to sell products in the EU can’t simply skirt the carbon market costs by relocating abroad, an economic phenomenon known as “carbon leakage.”

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For now, the world’s various carbon markets—in Europe, Canada, the US, China, and elsewhere—are disconnected, and carbon border tariffs could spark retaliatory trade wars. But in the long term, the global economy is clearly traveling toward universal, inescapable carbon pricing—so the earlier companies can cut their carbon footprints, the more of a competitive edge they’ll have in the future.