The overall volume of greenhouse gases that can be emitted by power plants, industry factories and aviation sector covered by the EU Emissions Trading System (EU ETS) is limited by a 'cap' on the number of emission allowances. Within the cap, companies receive or buy emission allowances, which they can trade as needed. The cap decreases every year, ensuring that total emissions fall.
Each allowance gives the holder the right to emit:
- one tonne of carbon dioxide (CO2), or
- the equivalent amount of other powerful greenhouse gases, nitrous oxide (N2O) and perfluorocarbons (PFCs).
Since the beginning of phase 3 of the EU ETS (2013-2020), the cap on emissions is set for the EU as a whole.
In phase 3 of the EU ETS (2013-2020), the Union-wide cap for stationary installations decreased each year by a linear reduction factor of 1.74%. The 2013 cap was set on the basis of the average total quantity of allowances issued annually in 2008-2012.
In phase 4 of the EU ETS (2021-2030), the cap on emissions continues to decrease annually at an increased annual linear reduction factor of 2.2%.
The Union-wide cap for 2021 from stationary installations is fixed at 1,571,583,007 allowances. The annual reduction corresponding to the linear reduction factor is 43,003,515 allowances.
From 2021, the UK is no longer part of the EU, however, pursuant to the Protocol of Ireland and Northern Ireland, the EU ETS applies to electricity generation located in Northern Ireland. These developments are reflected in the Union-wide cap for phase 4.
Allowances for the stationary installations are auctioned, unless they are allocated for free.
In accordance with the rules of the ETS Directive for phase 4 of the EU ETS, from 2021, around 57% of the Union-wide cap is auctioned and the rest is provided for free. These percentages are similar to the proportion of allowances auctioned and given for free in phase 3.
The level of free allocation per installation is determined taking into account benchmark values based on the average performance of the 10% best installations, the risk of carbon leakage of each sector and the historical activity level of each installation.
A uniform cross-sectoral correction factor may be applied in case the volume available for free allocation is higher than the calculated free allocation. 3% of the cap, initially earmarked for auctioning, is reserved as a free allocation buffer avoid or reduce the value for the cross-sectoral correction factor in case it needs to be used.
The auction volumes may be also used to compensate for attaining emission reduction targets in the sectors not covered by the EU ETS (flexibility between the EU ETS and non-EU ETS sectors).
In phase 4, 10 Member States with a GDP per capita below 60% of the EU average in 2013 may opt to continue allocating part of their auction volumes as free allowances to the energy sector up to 2030 under Article 10c of the ETS Directive. This is a derogation from the general rule that allowances will not be allocated for free to electricity installations. Only Bulgaria, Hungary and Romania have decided to use this derogation in phase 4.
The rules for setting the aviation cap in phase 4 are the same as for phase 3.
A bottom-up approach is used to determine the aviation cap:
- aviation allowances provided free of charge represent 82% of the aviation cap,
- 3% are set aside for the special reserve of new entrants and
- 15% of the aviation cap is auctioned.
From 2021 onwards, the same linear reduction factor that applies to stationary installations, 2.2% annually, will also apply to aviation allowances.
The number of aviation allowances to be issued in 2021 is approximately 24.5 million – some 20.7 million to be issued for free and some 3.8 million to be auctioned.