The EU Emissions Trading System (EU ETS) is based on the „cap and trade” principle, which since 2005 has required more than 11,000 industrial installations in the EU to hold allowances for every tonne of CO₂ they emit. The total emission cap (allowance pool) is lowered each year, which – with stable demand – drives up prices and incentivises reductions. In 2025, the average allowance price was €73.64 per tonne, while EU revenues from allowance sales reached approximately €43 billion, of which Poland generated €3.85 billion from a total volume of 52.5 million allowances sold.
The emissions trading system is the world’s largest carbon market and a key tool for implementing EU climate policy. For the average citizen, however, this mechanism often remains unclear – abstract allowances, exchange auctions and complex regulations raise questions about who gains, who loses, and whether the whole design actually leads to emission reductions. Understanding the logic of the EU ETS is essential both for businesses that must manage price risk and for analysts and policymakers facing the challenge of energy transformation.
The foundation of the system and market mechanism
The EU ETS operates on the „cap and trade” principle, meaning the European Union sets an upper limit on the total amount of greenhouse gases that installations covered by the system may emit, and then allows companies to trade allowances within that cap. Each allowance (EUA – EU Allowance) grants the right to emit one tonne of CO₂ equivalent.
The cap is reduced annually in line with EU climate targets, gradually decreasing the supply of allowances available on the market. In practice, companies that are able to reduce emissions below their allocated limit can sell their surplus allowances to those that emit more, thus creating an economic incentive to invest in cleaner technologies.
The system currently covers around 11,000 industrial installations in the power sector, steelmaking, cement plants, refineries, chemicals and aviation, as well as recently maritime and road transport under the new ETS2 system. These installations are required to monitor and report their emissions annually and to surrender the corresponding number of allowances. Failure to comply results in severe financial penalties. Since its launch in 2005, the EU ETS had contributed to a reduction in emissions from European power and industry of about 47 per cent compared with 2005 levels by 2023.
How the CO₂ emission price is formed?
The price of emission allowances is set by the market – primarily on the ICE Futures Europe exchange in London and the European Energy Exchange (EEX) in Leipzig. This is where both allowances sold in primary market auctions and those traded between companies on the secondary market are traded. The lower the annual emission cap (falling allowance supply) and the higher the demand from companies that have not been able to reduce their emissions sufficiently, the higher the allowance price.
In 2025, the weighted average price of EUA allowances on the ICE and EEX spot markets was €73.64 per tonne of CO₂. In December 2025, prices rose to around €82-85, only to fall to €68.1 per tonne in February 2026 – the lowest level since May 2025. These fluctuations reflect changing expectations about the pace of the energy transition, the availability of cheap abatement technologies and sentiment in financial markets.
Forecasts for the coming years vary. According to CAKE/KOBiZE analyses, allowance prices in the first quarter of 2025 were expected to be around €75, which proved accurate. Some experts predict that in 2026 the allowance price should break above €100 per tonne. Meanwhile, CRU analysts forecast that by 2030, real emission costs could exceed $150 per tonne of CO₂. Higher allowance prices provide a stronger incentive to cut emissions, but at the same time raise operating costs, particularly in energy‑intensive sectors.
Auctions and allowance allocation
New emission allowances are brought to market mainly through auctions organised on the ICE and EEX exchanges. Each Member State is allocated a certain pool of allowances to sell each year. Countries give away some allowances for free to designated entities, while selling the rest via auctions held every few days. Revenues from these auctions go to the budgets of the auctioning countries. In 2025, a total of 213 EUA allowance auctions (for the main ETS system) were held across the European Union, selling approximately 588.74 million allowances.
Total revenues from ETS allowance trading from 2013 to 2025 amounted to €198.3 billion for Member State budgets. In addition, revenues have been generated for the Modernisation Fund (€27.6 billion), the Innovation Fund (€13.4 billion), the Social Climate Fund (€3.7 billion) and the REPowerEU national recovery plan (€14.8 billion).
Some allowances are still given away for free, especially to sectors at risk of carbon leakage – i.e., the relocation of production outside the EU. For sectors deemed at highest risk of relocation, a 100 per cent free allocation is provided. For less exposed sectors, free allocations are being phased out – from a maximum of 30 per cent to zero by the end of Phase 4 (2030).
The benchmark values that determine free allocation levels are updated twice in Phase 4 to reflect technological progress and avoid undue windfall profits. The annual benchmark reduction factor ranges from a minimum of 0.2 per cent for sectors with slower innovation rates to a maximum of 1.6 per cent for sectors with faster emission reduction rates.
Free allowances and CBAM
One of the biggest challenges for the ETS is the risk of carbon leakage – moving production outside the European Union to countries with weaker climate regulations, which not only fails to help globally but actually harms the European economy. For years, free allowances for the most exposed sectors were used to counter this risk. However, this solution is gradually being phased out and replaced by a new instrument – the Carbon Border Adjustment Mechanism (CBAM).
CBAM requires importers of goods covered by the mechanism (cement, fertilisers, aluminium, steel, hydrogen and electricity) to purchase CBAM certificates covering the CO₂ emissions generated during the production of those goods outside the EU. The price of CBAM certificates is directly linked to weekly EU ETS allowance auctions. In practice, steel or cement imported from outside the EU face the same emission costs as those produced inside the EU. The CBAM transitional period ran from 1 October 2023 to 31 December 2025 and covered only reporting obligations. As of 2026, importers must actually purchase CBAM certificates.
Crucially, CBAM is closely linked to the phase‑out of free ETS allowances. The gradual reduction of free allowances in sectors covered by CBAM over 2026‑2034 will mirror the corresponding increase in CBAM obligations. This means that as European producers lose free allowances, importers from outside the EU must pay more for CBAM certificates, levelling the playing field. By 2034, free allowances for these sectors will be completely eliminated, and 100 per cent of emissions covered by CBAM will be subject to charges. However, export competitiveness remains a challenge – European producers selling their goods outside the EU receive no compensation for their emission costs, putting them at a disadvantage against competitors from countries without emissions trading systems.
A new system for transport and buildings
As of 2028 (postponed from the originally planned 2027), the ETS2 system will enter into force, extending emissions trading to the road transport and building heating sectors. ETS2 is a new, independent system running parallel to the existing EU ETS. Unlike the traditional system, which directly covers industrial installations, ETS2 is an „upstream” system – the obligation to hold allowances falls on companies that place fuels on the market (e.g. fuel and gas wholesalers), not directly on car drivers or people heating their homes. The emission cap for ETS2 in 2027 will be approximately 1.036 billion allowances, and will then be reduced by 5.1 per cent each year. The system will also cover small‑scale industry not previously covered by the ETS.
The delay of ETS2 until 2028 was agreed by the EU institutions in November 2025 to address concerns over competitiveness and high energy prices. As part of the compromise, a price safety mechanism was introduced: a price ceiling of €45 for allowances, and if that ceiling is breached in 2027‑2029, up to 80 million additional allowances could be released each year.
To mitigate the social impact of the new system, a Social Climate Fund has been set up, financed by ETS2 auction revenues. The ETS2 reporting period ran from 2024 to the end of 2027, and the full compliance obligation (i.e. the requirement to surrender allowances) will begin in 2028 for 2027 emissions.
Modernisation Fund and Innovation Fund
A significant share of the revenues generated by the ETS is used to finance the energy transition and low‑carbon innovation. Two key instruments in this regard are the Modernisation Fund and the Innovation Fund. The Modernisation Fund supports the modernisation of energy systems in ten EU countries with lower GDP per capita, including Poland – the largest beneficiary of the fund. It is financed by revenues from the sale of 4.5 per cent of the total allowance pool.
As of January 2026, the Modernisation Fund had disbursed more than €20.7 billion for 294 investments, including €1.8 billion for 45 new clean energy projects in 12 Member States. The fund supports projects that reduce greenhouse gas emissions in the energy, industry and transport sectors and improve energy efficiency.
The Innovation Fund is one of the world’s largest funding programmes for demonstrating innovative low‑carbon technologies. It is financed by revenues from the auctioning of EU ETS allowances – it is expected to provide around €40 billion of support in 2020‑2030. In December 2025, the European Commission announced a new call for proposals under the Innovation Fund worth €5.2 billion, of which €2.9 billion was allocated to the IF25 call for zero‑emission technology projects.
The fund supports demonstration projects for breakthrough innovations, including carbon‑free steel production, hydrogen, carbon capture and storage, and energy storage. Under the Clean Industrial Deal, the Commission announced its intention to strengthen the Innovation Fund and proposed the creation of an Industrial Decarbonisation Bank with a target funding of €100 billion.
The Polish dimension
Poland is one of the key players on the European emissions allowance market, both as a seller and as a recipient of funds from support mechanisms. In 2025, Poland sold a total of 52.532 million EUA allowances in 25 auctions, generating revenue of approximately €3.851 billion, with an average auction settlement price of €73.32 per tonne.
Poland’s total revenue from allowance sales from 2013 to 2025 was €31.585 billion, with a total volume of allowances sold of 851.366 million. For 2026, a total of 48.7 million Polish EUA allowances are planned for sale, although this volume will be reduced following the European Commission’s May notification.
On the other hand, Poland is the largest beneficiary of the Modernisation Fund, which means that part of the auction revenues flows back to the country for energy modernisation purposes. In 2024, Poland allocated 11 per cent of its ETS revenues (€615 million) to compensation for energy‑intensive industry for indirect emission costs.
The compensation scheme covers the partial reimbursement of electricity price increases caused by the ETS. In 2024, compensation was granted to 97 entities for a total of approximately PLN 2.9 billion. In 2026, the list of sectors eligible for compensation was expanded by another 22 sectors, and the European Commission eased state aid rules, allowing recovery of up to 80 per cent of indirect emission costs.
The ETS is of particular importance to Poland because of its coal‑based energy mix. In 2024, Poland recorded its highest ever share of renewable energy in power generation, but the power sector still relies heavily on coal, meaning Polish power plants are among the largest buyers of allowances on the market. The cost of CO₂ emission allowances accounts for a significant share of the average electricity price for industrial consumers in Poland, translating into higher electricity bills and an additional burden on the competitiveness of Polish industry. On the other hand, Poland is effectively using mechanisms to recover part of these costs through the compensation scheme and access to the Modernisation Fund, allowing the negative effects of climate policy on the economy to be mitigated.
In 2026, the European Commission is conducting a review of the future of the ETS after 2030, analysing how the system should be adapted to continue to stimulate and enable a cost‑effective transformation for its sectors. Under the Clean Industrial Deal, state aid frameworks have been adopted that give Member States the possibility of temporary price relief for energy‑intensive industry. For Poland, which faces the challenge of moving from coal to zero‑carbon sources, the shape of future ETS rules will be crucial for the pace and cost of that transformation, as well as for maintaining the competitiveness of Polish industry against other European Union countries.
Fot. Magnific
