The Emission Trading System (ETS) and Its History

Emission Trading System (ETS)

The Emission Trading System (ETS) is a trading mechanism that supports a low-emission development model. Within this system, businesses are allocated a certain amount of carbon emission allowances, which can be bought and sold. This allows companies to trade carbon permits among themselves. Although the widespread adoption of ETS is often associated with the Kyoto Protocol, which was adopted in 1997 and implemented in 2005, the concept of emission trading existed even before 2005. For example, in the United States, comprehensive amendments to the Clean Air Act in 1990 introduced market-based mechanisms, such as emissions trading, to reduce pollutants like SO2 and NOx. These mechanisms included setting limits on emissions, granting participants emission allowances, and allowing the trading of these allowances. These elements were later applied in similar ways in other emission trading systems. The Kyoto Protocol was significant for ETS because it promoted global acceptance and adoption of the system, bringing it onto an international platform. The protocol imposed limits on carbon emissions for early industrialized countries. Some countries implemented ETS as a Kyoto Protocol requirement, while others adopted it voluntarily.

How ETS Works

ETS operates on the “polluter pays” principle, using a cap-and-trade system. Its functioning begins with setting emission reduction targets for a specific period. These targets are determined by limiting greenhouse gas emissions for each company within a sector. Regulatory authorities allocate a certain amount of “carbon allowances” to companies. In ETS, a carbon allowance represents the right to emit a certain amount of CO2 equivalent per year. Each allowance corresponds to one ton of CO2 equivalent emissions. At the start of the compliance period, allowances are distributed to companies based on their capacity and operations, either free of charge or sold for a fee.

However, a company’s actual emissions may not exactly match its allocated allowances. Some may emit more or less than their allocation due to differences in abatement costs across sectors. Companies are allowed to buy or sell allowances in a designated market. Companies exceeding their targets can purchase additional allowances, while those reducing emissions beyond their allocation can sell their surplus. This creates a supply-and-demand market for emission permits. Companies failing to acquire sufficient allowances must pay penalties for each unit of excess emission, providing an incentive to meet reduction targets.

Example:

Suppose Companies A and B both initially emit 100,000 tons of CO2. For the next year, each is allocated 60,000 tons of CO2 allowances (25% below initial emissions). Company A can reduce emissions at lower costs, while Company B faces higher reduction costs. At the end of the period, Company A emits 10,000 tons less than its allowance, and Company B emits 10,000 tons more. Company A can sell its surplus 10,000 tons to Company B. If the market price is $20 per ton of CO2, the transaction amounts to $200,000.

For Company A, selling the surplus earns $100,000, rewarding the company for exceeding its reduction target. Company B purchases allowances for $200,000 instead of spending $300,000 on its own emission reductions, saving $100,000. This demonstrates that ETS provides economic incentives while ensuring emission reductions at a lower overall cost.

The effectiveness of ETS depends on which sectors are included, accurate emission calculations, and determining a suitable carbon price. If the carbon price is lower than the cost of low-emission technologies, companies are less incentivized to invest in cleaner technologies. Carbon pricing is influenced by the stringency of emission reduction commitments; stricter commitments generally result in higher carbon prices. Countries aiming to increase ETS effectiveness should gradually tighten annual emission reduction targets to maintain higher carbon prices.

ETS at the Global Level

ETS is widely implemented worldwide. Currently, 42 countries have active ETS programs. For example, New Zealand’s ETS, implemented in 2008, covers the entire economy, including forestry, fossil fuels, and power plants. Forestry is considered both an emission source (tree cutting) and an allocation source (tree planting). The agriculture sector currently has no binding obligations apart from annual reporting, though carbon pricing for livestock and fertilizer production is planned from 2025.

California’s ETS, effective from January 2013, covers 80% of the state’s emissions, aiming to reduce greenhouse gas emissions by 40% by 2030 and 80% by 2050.

ETS and Turkey

Turkey took its first step toward a domestic ETS in 2015 by establishing a Monitoring, Reporting, and Verification (MRV) system. Under this regulation, ETS-covered facilities include sectors such as aluminum, cement, paper, electricity, glass, iron-steel, lime, ceramics, mineral wool, refinery products, and chemicals. Facilities above certain sizes must report emissions to the Ministry of Environment, Urbanization, and Climate Change. The MRV system categorizes facilities into three groups: A, B, and C, based on emissions. Category A includes facilities emitting less than 50 ktCO2e, Category B emits between 50–500 ktCO2e, and Category C emits more than 500 ktCO2e. According to 2020 MRV data, there are 214 facilities in Category A, 136 in B, and 126 in C, totaling 476 facilities. Turkey’s total 2020 emissions were 520 MtCO2, with MRV-covered facilities responsible for 48.2% (250 MtCO2). Category contributions to MRV-covered emissions are 1.2% (A), 6.7% (B), and 92.1% (C).

The pilot ETS application, starting October 15, 2024, will initially include only Category C facilities, with full implementation planned for October 15, 2026.