How does emissions trading work?
At the heart of the ETS is the common trading “currency” of emission allowances. One allowance gives the holder the right to emit one tonne of CO2. For each trading period under the scheme, member states draw up national allocation plans that determine how many emission allowances each installation receives. The “cap,” or limit, on the total number of allowances granted is what creates scarcity in the market. Companies that keep their emissions below the level of their allowances can sell their excess allowances. Those facing difficulty in keeping their emissions in line with their allowances have a choice between taking measures to reduce their own emissions, such as investing in more efficient technology or using less carbon-intensive energy sources, or buying the extra allowances they need on the market, or a combination of the two. Such choices are likely to be determined by relative costs. In this way, emissions are reduced however it is most cost-effective to do so.
