The EU Emissions Trading System (EU ETS) has done nothing to incentivise the development of new technologies. It has allowed those companies with cash to buy their way out of the decarbonisation problem, rather than innovate and create technologies to solve it. This was the view of Vicki Hollub, president and CEO of US energy company Occidental, in a recent interview with Petroleum Economist.
Such a scathing assessment of the EU ETS will of course be fiercely contested in the corridors of power in Brussels. The scheme is the world’s largest and most liquid cap-and-trade market, and its design is being replicated by a growing number of governments around the world.
However, 21 years on from its launch, the extent to which the scheme has driven decarbonisation by incentivising investment in new technology, and/or forcing industries to cut their emissions from existing processes, is perhaps not as clear cut as its architects in Brussels would have hoped when they pressed ‘go’ on New Year’s Day 2005.
The EU undoubtedly made a significant breakthrough in getting the scheme up and running in the first place. Incessant wrangling over the level of CO₂ caps imposed on various industries across the bloc, and arguments over the initial allocation of free allowances, could have scuppered its chances of making it to launch. Concerns about the cost to industry and resulting loss of global competitiveness because of the EU’s world-leading climate policy were very real at that time and remain so today.
The EU persevered, and the world’s first major cap-and-trade scheme went live to much fanfare, representing the first major step in the EU’s world-leading mission to curb emissions.
The early years were touch and go. An oversupply of tradeable allowances at one stage drove the price perilously close to zero. Ensuing price volatility was partly the result of an upsurge in speculative dealing in allowances by banks and traders, rather than emitters, drawing criticism from some.
Cheap carbon
The price subsequently recovered, but even in 2025 it remains at a level that many regard too low to make a real difference, persistently trading below €100/t CO₂ ($116/t CO₂). Forecast for the next decade or so are mixed, but few analysts expect a meaningful surge in the price in the near to medium term.
Developers of CCS projects warn the price is too low to drive investment in their sector. Ditto for clean hydrogen, direct air capture, bioenergy with carbon capture and other emerging technologies. In other words, the low EU ETS price means it is still much cheaper to buy allowances to prove emission reductions than to invest in new technologies.
Hence the need for hefty operating subsidies to make these technologies even remotely bankable. The EU ETS does at least provide a benchmark that can be used to settle instruments such as contracts for difference, where subsidies cover the cost gap between the traded carbon price and the actual cost of CO₂ mitigation.
The EU has tried to strengthen the scheme through repeated tweaks over the years and by expanding it to include new sectors, including aviation, which was added in 2012.
However, one could be forgiven for thinking the EU has lost some of its early faith in the ability of the scheme to become the region’s primary engine of decarbonisation. Over the years, it has been crowded out by a multitude of new climate policies, the latest of which is the Industrial Accelerator Act, which is expected to include yet more measures aimed at supporting the scale-up of CCS, clean hydrogen and other transition tech.
Innovation fund
The EU ETS has made significant contribution to decarbonisation via the EU Innovation Fund. This funding programme, financed entirely from EU ETS revenues, has so far awarded €12b of capital grants to a range of low-carbon technology projects. However, the funding is reliant on the EU ETS price of carbon, exposing it to market volatility. The EU reckons the fund can deliver funding worth €40b over 2020–30, based on a carbon price of €75/t.
The EU ETS has also made real impact on the power sector, helping to drive the switch away from coal-fired generation. Even at current prices, the cost of carbon leaves coal-fired power in the EU out of the money most of the time. That said, significant rallies in gas prices, as in the wake of Russia’s invasion of Ukraine, can leave coal as the more profitable option at times of peak power demand for generators in markets including Germany.
Cap-and-trade market enthusiasts argue that putting a tradeable price on CO₂, so externalising the cost of emitting, is ultimately the best way to deliver a low-carbon economy. A growing number of governments and US states appear to agree, though not the White House.
However, the problem with the EU ETS, and other cap-and-trade markets, is that they are essentially policy-led. The supply side, in the form of allowances, is dictated by policymakers, hampering the market’s ability to deliver a price that truly reflects key fundamentals such as the real cost of mitigating emissions.
History will judge the success of the EU ETS and its role in the net-zero project over its next 21 years in operation, assuming it is not traded in for an alternative policy in the meantime.
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