The European Union Emissions Trading System (EU ETS), which puts a price on the CO₂ emissions driving climate change, has for years been the main engine of decarbonisation in energy and industry. The EU is now building a similar system – ETS II – for the transport and buildings sectors. Because of low carbon allowance prices, the ETS was long seen as a fairly ineffective climate policy tool, but recent reforms have pushed prices up, prompting companies to cut their consumption of fossil resources. In 2026 and 2027 the EU is refining the system to prepare for the period after 2030. This article looks at the ETS's objectives, rules, historical price development, the reforms made so far and future prospects, including the European Commission's reform proposals of 17 July 2026.
What is the EU ETS?
Through the EU ETS, the European Union has created a market mechanism that puts a price on CO₂ and gives companies a financial incentive to cut emissions in the most cost-effective way. It is the cornerstone of EU climate policy. The original ETS I aims to cut emissions from power generation and energy-intensive industry – for example iron, aluminium, cement, glass, paper and acid production – by a set percentage every year. If the current rules, in force until 2030, were simply extended, emissions would reach zero by 2039, though upcoming reforms are likely to change that timetable.
Between 2005 and 2023 the system helped cut emissions from the sectors above by roughly 47%. Figures for 2023 show a record drop of 15.5% compared with 2022, driven largely by a boom in renewable energy. According to a 2024 report by the International Carbon Action Partnership (ICAP), the EU ETS is the oldest and by far the largest of the 36 carbon trading systems operating worldwide, together covering 18% of global emissions.
From 2027, a new emissions trading system will cover fuel distribution for road transport and building management, as well as industrial sectors not yet covered. ETS II will initially run in parallel with the original system, with the two due to be merged in the early 2030s.
The cap-and-trade principle
Companies must buy or receive allowances matching the CO₂ they produce, which makes electricity generation from coal and other fossil resources more expensive while making clean energy sources more attractive.
The EU ETS is based on the so-called cap-and-trade principle. Brussels sets a maximum permitted volume of CO₂ emissions, or “cap”, which is reduced every year; companies need a European Union Allowance (EUA) for every tonne of CO₂ emitted in a calendar year. Companies buy these allowances or receive them free of charge, and may trade them. At the end of the year, companies surrender allowances matching their actual emissions volume.
The EU ETS covers CO₂ emissions from power plants, energy-intensive heavy industry and civil aviation. Flights outside the EU or to airports outside it are not covered; the rules apply only to flights within the European Economic Area (EEA). From this year, the system also covers maritime transport emissions.
Heavy industry receives a certain share of free allowances so it can compete with companies outside the EU that are not subject to such strict climate legislation.
If a company emits more CO₂ than its allowances cover, it faces a penalty of €100 for every excess tonne. This motivates companies to invest in energy efficiency to cut emissions, since they can sell any allowances left over. For comparison, the world's largest chemicals group, Germany's BASF, generated 20.2 million tonnes of CO₂-equivalent direct and indirect emissions in 2021.
Revenue from the EU ETS mainly flows into member states' budgets or is channelled into the EU Innovation Fund and Modernisation Fund. In 2022, total EU ETS auction revenue came to €38.8 billion, €7.7 billion more than in 2021. Of that sum, €29.7 billion was distributed to member states; Germany's revenue reached €7.8 billion.
What is the emissions reduction target under this system?
The system, covering the 27 EU member states as well as Iceland, Liechtenstein and Norway, includes around 9,000 power plants and factories, accounting for roughly 36% of all EU greenhouse gas (GHG) emissions (2022 figures).
The EU ETS aims to cut GHG emissions by a set percentage every year, known as the linear reduction factor (LRF). From 2013, the LRF was set at 1.74%, intended to bring about a 21% cut in total emissions by 2020 compared with 2005. For the 2021–2030 period, an annual allowance reduction of 2.2% was originally planned. This factor was approved in 2018 to align it with the EU's earlier target of cutting total GHG emissions by at least 40% by 2030 compared with 1990.
The 2023 reform introduced more ambitious targets for the current ETS Phase 4 (2021–2030): total emissions must be cut by 62% by 2030 compared with 2005. The LRF is being raised to 4.3% for 2024–2027 and to 4.4% from 2028.
On this trajectory, emissions would reach zero in 2039, excluding a small share of allowances reserved for the aviation and shipping sectors. Once the EU agrees its climate targets for 2040, the ETS parameters will be adjusted again.
What's new in the 2023 reform of EU ETS I?
The European Climate Law took effect in mid-2021, setting a binding target of cutting net greenhouse gas emissions by at least 55% by 2030 compared with 1990. To achieve this, the European Commission unveiled the Fit for 55 legislative package in July 2021, which also included an overhaul of the ETS. After negotiations, the European Parliament, the Council of the EU and the Commission reached agreement in December 2022 on the ETS I reform and on setting up a second system – ETS II – for transport and heating. The final legislation was signed in 2023.
Key changes
The new 2030 target is a 62% cut in ETS-sector emissions compared with 2005, up from the previous 43%.
New linear reduction factor: 4.3% from 2024 to 2027 and 4.4% from 2028 to 2030.
Use of revenue: member states must channel all revenue from allowance trading into climate-related measures.
Shipping: maritime transport emissions are being brought into the scope of the ETS in stages. Emissions from voyages outside the EU will be covered at 50%, while domestic and intra-EU voyages will be covered at 100%. The obligation to surrender allowances is phased in gradually: 40% of verified emissions from 2024, 70% from 2025 and 100% from 2026. It currently applies only to large ships with a gross tonnage above 5,000.
Phase-out of free allowances and CBAM: free allowances for companies will be gradually reduced and fully phased out by 2034 for goods covered by the Carbon Border Adjustment Mechanism (CBAM), such as cement, steel and fertilisers. From 2026, the allocation of free allowances will depend on a company's investment in energy efficiency and emissions reduction.
Aviation: Europe has agreed to fully phase out free allowances for airlines on intra-European flights by 2026, moving to full auctioning. From 2025, the system will also monitor aviation's non-CO₂ impacts. Flights outside the EU will be covered by the international CORSIA scheme, integrated into the overall ETS.
Waste incineration: emissions from waste incineration have been monitored since 2024, and are planned to be included in the system from 2028, with member states able to postpone this until 2030.
Market Stability Reserve (MSR): 24% of all ETS allowances will continue to be placed into the reserve, reducing the historical surplus of allowances and allowing a more flexible response to market shocks and demand fluctuations.
The new trading system for transport and buildings – ETS II
As part of the Fit for 55 reforms, Europe approved ETS II, a separate system covering fuel distribution for road transport, heating of buildings, and additional industrial sectors not covered by the first system. The European Commission has said that reductions achieved so far in these sectors have been insufficient to meet the 2050 climate-neutrality target.
Basic principles of ETS II
The European Union has officially agreed to push back the full launch of the new ETS II emissions trading system to 2028, a year later than originally planned. The decision to delay the system followed pressure from several member states, including Poland, Slovakia and Hungary, to give countries and citizens more time to prepare for the coming price increases and to ease social pressure.
Mandatory monitoring and reporting of greenhouse gas (GHG) emissions has already been under way since 1 January 2025. No payments apply at this stage. From 2028 the system becomes fully operational and formal ETS II allowance trading begins. This means fuel suppliers will have to buy allowances for every tonne of CO₂ generated by the fuel they sell.
The first actual surrender of allowances: companies will have to settle their accounts for emissions generated in 2028 during 2029. The system will directly affect fuel distributors supplying fossil resources.
The system operates at the upstream level, meaning the rules apply to fuel and heating-fuel suppliers/distributors rather than directly to households or drivers. Suppliers have to buy allowances for the volume of fuel they place on the market. The aim is to cut emissions in these sectors by 42% by 2030 compared with 2005. There are no free allowances – the entire volume is auctioned, since these sectors are not exposed to global competition or the risk of carbon leakage.
Member states may exempt suppliers from participation until 2030 if the country already has a national carbon tax equal to or higher than the ETS II price.
Use of revenue: funding must be directed towards climate measures and social support. Part of the revenue will go into the EU Social Climate Fund to help low-income households and micro-enterprises.
Price stability mechanism: if the allowance price exceeds €45 in the first three years, additional allowances will be released onto the market to stabilise the price.
In Germany, which already has a similar national system, researchers warn of a possible sharp price rise once the EU-wide system takes full effect. Because allowances are traded on the open market, forecasting an exact ETS II price is difficult.
The future development of the ETS
The system has been reformed several times to adapt to new trading periods, bring in new sectors and prevent unforeseen price swings.
Only very recently – on 17 July 2026 – the European Commission unveiled a new proposal for the next ETS reform, to prepare the system for the period after 2030. The Commission is facing strong pressure from businesses and some governments demanding that the burden on struggling sectors be eased. The initial proposal drew sharp criticism from climate protection organisations and a mixed response from industry representatives. At its core, the proposal involves a slower reduction of the emissions cap after 2030 and the retention/extension of free allowances for certain sectors.
How have emissions trading system prices changed over the years?
In the first two trading periods – 2005–2007 and 2008–2012 – most allowances were handed out free of charge and in large volumes, which caused the allowance price to fall to zero in 2007.
In the third phase (2013–2020), 40% of allowances were already auctioned, requiring power producers to buy them, with a few exceptions in countries such as Poland and Bulgaria. Since 2021, around 57% of the total volume has been auctioned. However, generous free allocation to manufacturing industry and aviation, together with the 2008 global financial crisis, created a huge surplus of allowances. The price fell from €30 in 2008 to €2.75 in 2013.
After the 2018 reform, which limited the volume of free allowances, prices began rising sharply – from €9.68 in 2018 to a historic record of €100 a tonne in early 2023.
By early 2024, however, the price had slipped back to around €60. This is explained by lower natural gas prices, cleaner electricity generation, falling industrial demand and the REPowerEU plan. To reduce dependence on Russian energy resources, the EU carried out a “frontloading” of allowances, or frontloading – selling future allowances earlier, which increased market supply between 2023 and 2026. Experts, including the carbon market analytics firm Veyt, forecast that prices will rise again in the long term, reaching around €130 per allowance by 2030.
Relevance and impact in Latvia
Latvia has been a full participant in the EU ETS since its inception in 2005, but the structure of the Latvian economy means the system's impact here plays out somewhat differently than in Europe's large industrial states.
Latvia's ETS I specifics – industry and energy
Traditionally, most EU ETS emissions in Europe arise from energy and heavy industry, where the system covers installations with a capacity above 20 MW. While in Europe on average these large operators generate roughly half of all GHG pollution, in Latvia they account for only about 27% of the country's total emissions. This is because Latvia has no large heavy industry, while hydropower and biomass – wood, which is not subject to ETS charges – have historically played a major role in electricity and heat production. ETS I directly affects Latvia's large district-heating operators, such as Rīgas Siltums, energy companies (Latvenergo) and individual large producers such as the Schwenk Latvija cement plant.
Rolling out the new ETS II system and public concern
Since most of Latvia's emissions arise outside the existing ETS, mainly in transport and household heating, the rollout of the new ETS II system will affect Latvia much more directly and broadly.
Legislative amendments: to transpose the European directives, following political debate and concerns over fines that could have reached as much as €300 million, the Saeima passed amendments to the Pollution Act. These add to the circle of ETS participants in Latvia all wholesale and retail fuel and heating-fuel suppliers who release products for final consumption.
Social impact and price concerns: given that fuel traders are likely to pass the full cost of ETS II through to consumer prices, a broad public debate has begun in Latvia's media, including public broadcasters and major news portals, about the coming rise in transport and heating costs. As of mid-2026, there is still no clear, state-approved support mechanism for the households that this cost increase will hit hardest.
Where does Latvia's revenue go?
The money Latvia earns from auctioning allowances on the open market enters the state budget through the Emission Allowance Auctioning Instrument (EKII). The Ministry of Climate and Energy (KEM) stresses that these funds are reinvested in a targeted way in decarbonising the economy.
The priority areas for this funding in Latvia are support for low-income households to improve energy efficiency and insulate buildings, and the transport sector's shift towards more environmentally friendly solutions – for example, Latvia recently received €40 million in European funding to replace diesel buses in the regions with electric buses and develop a charging network.
Since audits by the State Audit Office indicate that Latvia still risks missing its 2030 climate targets, specifically in the transport sector, because of fragmented governance, the rollout of ETS II and the correct use of EKII revenue will be a decisive factor for the country's economy in the coming years.
Fuel and heating price forecasts under ETS II after 2027
The rollout of the new EU ETS II system in 2027 will directly affect the price of fossil fuels, as the carbon price will be built into every litre or cubic metre sold by suppliers. Diesel and petrol: if the market price of carbon allowances reaches the EU's planned stability ceiling of €45 per tonne of CO₂, fuel prices at Latvian filling stations will rise by roughly 10 to 12 cents per litre, plus VAT.
Pessimistic scenario: if demand across Europe is high and the market price exceeds the stabilisation mechanisms, analysts consider a price rise of as much as 20–25 cents per litre possible.
Impact on heating costs
Natural gas and heating diesel: for households that still use natural gas for heating, bills could rise by roughly 10–15%.
District heating: in towns where heating networks still depend on gas, a similar tariff increase is expected. By contrast, in towns that have switched to wood chips or biomass, the impact will be minimal, since renewable resources are not subject to this charge.
Notably, the Ministry of Climate and Energy plans to draw on part of the European Social Climate Fund, under which Latvia has an indicative allocation of around €617 million, specifically to offset this cost increase for socially vulnerable groups.
EKII and state support programmes for households
The Emission Allowance Auctioning Instrument (EKII) and other state programmes offer generous financial support to help people prepare for the price rises and move away from fossil fuels.
Solar panels and the new priority – batteries
The EKII programme for private houses, administered by the Environmental Investment Fund (VIF), currently covers up to 70% of equipment purchase costs. The combined maximum support is up to €6,500 if a project combines solar panels with a battery storage system. For solar panels alone, depending on the installed capacity (kW), the maximum co-financing is up to €4,000.
Batteries (BESS): the state now grants up to €2,500 specifically for the purchase of battery units with a minimum capacity of 5 kWh. The aim is to encourage self-consumption, so people use their own energy in the evenings without adding load to the distribution network. A key condition is that at least 80% of the electricity generated per year must be self-consumed, so system capacity must be carefully matched to actual consumption. Support is also available for new builds that have a cadastre number and completed roof works.
Replacing heating systems
The state is increasingly supporting smart hybrid systems. If you want to replace an old gas or solid-fuel boiler, the EKII and CFLA programmes offer co-financing for installing heat pumps (air-to-water, ground-to-water) and for buying biomass pellet boilers. As an additional bonus, an especially increased level of support for purchasing this equipment is available to large families, i.e. holders of Latvia's Goda ģimene [Family of Honour] card.
Insulating private houses and apartment buildings
To cut heat energy consumption – the best way to counter the extra costs brought by ETS II – two main sources of funding are available. For apartment buildings, there is an active KEM and ALTUM programme with a multimillion-euro fund providing capital grants of up to 50% of the eligible costs of an energy-efficiency project.
For private houses: through ALTUM, energy-efficiency grants and subsidised loans are available for insulating a house's building envelope – walls, roof, basement – as well as for replacing windows and doors.
Funding under these programmes is allocated on a first-come, first-served basis. Applications and the exact rules for submitting projects are available on the EKII.lv platform or on the ministry's official websites.
Latvia – possible future risks and problems
As the EU ETS II system is rolled out from 2027, Latvia will face several critical risks. Because this system will directly tax transport fuel and building heating, there are real scenarios that could trigger a socio-economic crisis or political deadlock in the country.
Social crisis and “energy poverty”
Latvia has a large share of low- and lower-middle-income households living in uninsulated homes and driving older cars. The state support on offer – for heat pumps or electric cars – requires a significant own contribution. A low-income resident in the regions cannot afford to invest €7,000 in a heat pump, even if the state promises to refund half. These households will be forced to keep buying expensive gas or diesel, paying the full ETS II price, which will dramatically deepen energy poverty and the social divide.
A “price shock” and an inflation spiral
ETS II is based on a market mechanism – the allowance price is set by demand across the whole of Europe. The EU has built in a stability mechanism so the price does not exceed €45 per tonne of CO₂. However, many European energy analysts warn that if demand for allowances in Germany and other large states is huge, the market price could exceed this ceiling. If fuel prices rise not by the promised 10 cents but by 20–25 cents a litre, this will instantly push up costs throughout supply chains, in food shops and in public transport, triggering a fresh wave of inflation in Latvia.
Collapse of regional mobility
Unlike in Rīga, public transport in Latvia's regions and small towns often runs only a few times a day. There, a car is not a luxury item but the only way to get to work, school or the doctor. Making fuel more expensive without providing an alternative public transport network will be a heavy blow to economic activity in the regions. For people from small towns, working in regional centres could become financially unviable.
Administrative and “grey market” risks
Because responsibility for buying allowances falls on wholesale and retail suppliers of fuel and heating fuel, there is a risk of fraud schemes. Firewood and wood pellets are not covered by ETS II. As gas and briquette prices rise, demand for firewood will grow rapidly. This could cause an uncontrolled rise in the price of local fuel and encourage illegal, untaxed firewood trading. If fuel remains cheap in neighbouring non-EU countries such as Belarus and Russia, the widening price gap could again make smuggling and cross-border trading of illegal fuel economically attractive.
Delays in absorbing European Social Climate Fund money
Europe has set up a fund from which Latvia will have access to more than €600 million specifically to mitigate these risks. Latvia's track record shows that it often takes years for ministries – the Ministry of Climate and Energy and the Ministry of Welfare – to draft precise rules and channel money to those who need it most. If the fund's money gets “stuck” in official corridors, the ETS II price shock will reach the public faster than state help does…