Enhancements have been implemented within the system to boost its operational efficiency.
European Union Carbon Market Evolves Amidst Expansion and Global Interactions
The European Union's carbon market, known as the Emissions Trading System (EU ETS), is undergoing significant changes, with key developments shaping its future and influencing global carbon markets.
For the first time, maritime transport was included in the EU ETS calculation system in 2024, reporting around 72 million tonnes of CO2. Meanwhile, the power sector contributed significantly to the emissions decrease, with a +8% increase in production from renewables and a +5% increase from nuclear. However, aviation emissions increased by 15% in 2024.
One of the most significant changes is the implementation of the EU Carbon Border Adjustment Mechanism (CBAM), starting in 2026. This mechanism will impose fees on imports based on their carbon content to prevent carbon leakage and protect EU industry competitiveness. The European Commission plans to deliver legislative proposals in 2025 to strengthen CBAM, addressing loopholes and potentially expanding its scope to cover more sectors and downstream products.
Another key development is the expansion of the EU ETS, known as ETS2, which is set to take full effect in 2027 and will extend emissions trading to transport and heating sectors. This expansion faces political challenges due to social costs from rising prices but is expected to proceed with mechanisms to moderate price volatility while preserving incentives for emissions reductions.
The EU ETS is also expected to enlarge to include new member states, which will significantly increase allowance supply and demand, requiring adjustments to market stability mechanisms like the Market Stability Reserve to avoid price shocks.
Moreover, the integration of carbon removals and international offsets is being considered. The European Commission’s 2040 climate targets include amendments proposing the integration of domestic permanent carbon removals into the EU ETS to compensate residual emissions from hard-to-abate sectors. It also permits limited use of international carbon credits under Article 6 of the Paris Agreement, capped at 3% of EU emissions, starting around 2036.
India and Turkey, major trading partners of Europe, are discussing new CO2 credit programs. The return of global CO2 prices to pre-Ukraine invasion levels creates an opportunity to invest or rebalance positions in Europe, California, or the global basket of CO2 markets.
As the EU carbon market evolves, it is positioning itself as a strong driver of both regional and global carbon market progress over the next decade. Other countries are expected to adopt carbon pricing mechanisms in response, leading to closer interactions between the EU ETS and other carbon pricing systems internationally. This trend could eventually facilitate market linkages or mutual recognition of credits.
In conclusion, the EU carbon market is evolving rapidly with CBAM fostering cleaner trade flows, ETS expansion into new sectors and countries increasing market size, and integration of offsets/removals transforming credit use. Political and technical challenges remain, but these developments position the EU ETS as a significant player in the global fight against climate change.
[1] European Commission. (2023). EU Carbon Market Outlook 2023-2030. [2] European Commission. (2022). Proposal for a Regulation of the European Parliament and of the Council on the Market Stability Reserve. [3] European Commission. (2021). Communication from the Commission to the European Parliament, the Council, the European Economic and Social Committee and the Committee of the Regions - Carbon markets: state of play and the way forward. [4] European Parliament. (2020). Report on the EU Emissions Trading System (EU ETS) reform.
- As the European Union's carbon market evolves with CBAM, ETS expansion, and integration of offsets/removals, it's anticipated that other countries will adopt similar carbon pricing mechanisms, fostering closer interactions with global carbon markets, potentially leading to market linkages or mutual recognition of credits.
- With the EU Carbon Border Adjustment Mechanism (CBAM) starting in 2026, this mechanism will impose fees on imports based on their carbon content, impacting not only the EU's environmental-science and climate-change efforts but also financial markets, including investing and real-estate sectors.
- The European Union's carbon market expansion to include new member states in 2027 will significantly increase allowance supply and demand, requiring adjustments to market stability mechanisms like the Market Stability Reserve to maintain a stable environment, ensuring that work within the finance sector remains efficient and productive.
