How does the EU ETS work?
Each EU member state must develop a National Allocation Plan (NAP) approved by the European Commission. This sets an overall cap on the total emissions allowed from all the installations covered by the system. This is converted into allowances (one allowance equals one tonne of CO2), which are then distributed by EU member states to installations covered by the system.
At the end of each year, installations are required to surrender allowances to account for their actual emissions. They may use all or part of their allocation. Installations can emit more than their allocation by buying allowances from the market. Similarly, an installation that emits less than its allocation can sell its surplus allowances. The environmental outcome is not affected because the amount of allowances allocated is fixed.
The EU ETS covers electricity generation and the main energy-intensive industries – power stations, refineries and offshore, iron and steel, cement and lime, paper, food and drink, glass, ceramics, engineering and the manufacture of vehicles. Combined, these account for around 48% of UK CO2 emissions.
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