The EU Emissions Trading System: What Companies and Investors Need to Know

The EU is on a mission to reduce greenhouse gas (‘GHG’) emissions especially from the highest emitting industries. To do this, they’ve come up with a system that aligns environmental goals with financial interests. Historically, transitioning to a more sustainable business has often been seen as a costly burden for businesses. The EU is flipping that narrative by making emissions themselves costly.

What Is the EU ETS?

The EU has created a system called the Emissions Trading System (ETS). It sets a limit or “cap” on the total amount of CO₂ that certain industries are allowed to emit. Within this cap, companies receive a number of carbon allowances for free. Each allowance lets them emit one ton of CO₂:

• If a company emits more than its allowance, it must buy extra permits from others.
• If it emits less, it can sell its unused permits for profit.

This creates a market for carbon emissions with a real price tag on every ton of CO₂.

The cap tightens annually, making emissions more expensive over time and ensuring alignment with the EU’s 2030 and 2050 climate targets. As the cap gets tighter, permits become scarcer and more expensive. That’s the genius of the system: it makes reducing emissions a financial win. Instead of seeing climate action as a cost, companies now have a money-saving (or money-making) reason to invest in cleaner, more efficient technology.

On top of that, failure to comply can result in fines. More concretely, 100 euros per excess tonne of CO₂, plus the obligation to purchase missing allowances. Non-compliance also risks reputational damage and loss of operating licenses in regulated sectors.

The targeted sectors are:

Carbon Dioxide (CO₂)

• Electricity and heat generation
• Energy-intensive industries, including:
   
  • Oil refineries
   
  • Steelworks and iron production
   
  • Aluminium and other metal production
   
  • Cement, lime, and glass manufacturing
   
  • Ceramics and brickworks
   
  • Pulp, paper, and cardboard production
   
  • Chemical industries: acids (e.g. nitric, adipic, glyoxylic) and bulk organic chemicals
 
• Aviation
  
   
  • Intra-European flights (within the European Economic Area)
   
  • Departing flights to Switzerland and the United Kingdom
 
• Maritime transport
  
   
  • 100% of emissions from voyages between EU ports or within EU ports
   
  • 50% of emissions from voyages entering or leaving the EU

Nitrous Oxide (N₂O)

• From the production of:
   
  • Nitric acid
   
  • Adipic acid
   
  • Glyoxylic acid and glyoxal

Perfluorocarbons (PFCs)

• From the aluminium production process

Is the EU ETS working?

The ETS launched in 2005. For years, permit prices were too low to drive real change, especially after the 2009 financial crisis, when there was a glut of unused permits. Since then, carbon prices rose steadily and peaked in 2023, pushing energy and electricity producers to cut emissions significantly. Unfortunately, prices dipped again recently, due once again to oversupply.

Still, the EU ETS remains an ambitious tool. It’s currently undergoing a significant reform as part of the EU’s “Fit for 55” package, which aims to reduce emissions by 55% by 2030 (taking 1990 levels as a baseline). It is expected that in 2027 a new ETS2 system is adopted for buildings and road transport fuel suppliers.

Lastly, the EU ETS still has one flaw: If European producers face a carbon price, but foreign competitors do not, carbon leakage can occur. That is, production and emissions could shift to countries with looser climate rules, relocating the adverse impact in the other continents rather than removing it. Therefore, the Carbon Border Adjustment Mechanism (CBAM) was designed to prevent carbon leakage by pricing emissions in imports of steel, cement, and other products.

Why It Matters for Businesses and Investors

Carbon pricing directly affects a company’s cost structure. For carbon-intensive businesses, this can materially impact EBITDA margins and long-term valuations. It’s especially relevant for:

• Portfolio companies in energy, heavy manufacturing, or aviation
• Closing M&A deals with under-optimized emissions strategies
• Corporates with legacy assets facing stranded asset risk

Proactive decarbonization strategies, such as process electrification, renewable energy adoption, or carbon capture can reduce exposure to rising EUA prices. This is increasingly a differentiator in due diligence and exit planning.

Therefore, for investors in the affected sectors, the EU ETS should be viewed not only as a compliance issue but as a strategic lever:

• Deal Screening: Evaluate carbon pricing exposure in early-stage due diligence.
• Valuation and Exit: Identify how ETS costs (or savings through reductions) impact enterprise value.
• Governance: Ensure portfolio companies have robust carbon accounting, disclosure, and allowance procurement strategies in place.

We can help you calculate your GHG emissions and design a decarbonisation strategy that makes sense for your business.