A guide to the EU Emission Trading System for climate tech founders and VCs
Second in Rubio’s deep dives series is a look into the EU Emission Trading System (ETS); the world’s largest carbon emission trading scheme put in place to reduce emissions of carbon dioxide and other greenhouse gasses cost-effectively in the European Union. We dove into the working principles of the system to uncover the dynamics of emission trading and pricing and what climate tech founders and VCs can learn.
Here’s how it all works
Established in 2005, ETS covers more than 10,000 companies across heat and energy generation, heavy industry, commercial aviation, and more. In line with the EU Green Deal, the trading system aims to keep us on track for Net Zero by 2050.
The EU ETS follows a “cap-and-trade” system, meaning there is
A set cap on the total amount of greenhouse gasses (GHGs) measured in a company’s “allowances” to emit (1 allowance = 1 tonne GHG)
The ability to trade allowances, with those emitting less than their cap selling, and those emitting more buying
source: https://www.senken.io/glossary/eu-ets
The intent is to incentivise companies by both the ability to earn income from faster decarbonisation (i.e. they can sell the difference in allowances between their actual emissions and their cap), and the fines they will receive if their emissions exceed the total allowances they have been allocated or traded for that year.
And one last important point: Every year, the EU Commission reduces the cap across all sectors to ensure overall emissions fall.
Insight 1: The rapidly decreasing carbon supply, not their fluctuating prices, will drive your climate tech sales pitch
The efficacy of the ETS system is often questioned due to historically low prices of allowances. After the introduction in 2005, prices didn’t exceed €30 per tonne in the first 15 years of the system’s existence; which is seen as too low to financially push companies towards decarbonization. And while there was a spike to €100 per tonne in 2021, spurred by the EU Green Deal implementation and Russia’s invasion of Ukraine, prices have since dropped back to earth.
Despite this, historical emission data shows a 47% reduction in the sectors covered between 2005-2023 so something is clearly working! And (spoiler alert) it’s the cap.
This decarbonisation has all occurred in the context of the EU Commissions steadily tightening the screws on the system’s cap, increasing the annual reduction factor from 1.72% in 2013 towards 4.3% by 2028. Over the long term, regulatory pressure and an aggressively decreasing cap, not short term prices, have been effective drivers.
Most important pain point For climate tech founders (and their investors), the implication is that forward planning (“i.e. we don’t want to be punished for exceeding the cap in future”), not the price today, is the most important pain point for companies impacted by the ETS. That means focussing your sales pitch to corporates on the long term risk mitigation you can provide, rather than trying to extrapolate too much from volatile (and evidently immaterial) carbon costs today.
Insight 2: Until free allowances are removed, only energy tech (and not industrial climate tech) really benefits from the ETS system
So every year, the decreasing cap squeezes another chunk of emissions out of the system. But here’s the real twist: not all companies feel the same pressure to clean their old furnaces. Some companies get additional free allowances, while others don’t.
The main difference is between tradable and nontradable goods. Tradables are the products that can be packaged up and shipped like steel, cement, chemicals and fertilizers, while non-tradables are produced close to the location of consumption, like electricity.
Because tradable goods can be shipped long distances, they have a high risk of “carbon leakage”, meaning those corporations threaten to move their operations outside the EU if the carbon cost is too high domestically.
As a result, companies like Tata Steel and Yara (producing fertilizers) in the Netherlands are given more free allowances than they need, eliminating any incentive to change under the current scheme. Meanwhile, energy utilities like Vattenfall, RWE and Uniper pay full price for their emissions because there’s no risk of “carbon leakage”: they can’t just relocate energy generation across a border because of steep losses in electricity transport.
This means that while energy sector investors and founders working on decarbonising the grid can count on the ETS fueling change today, ventures decarbonising steel, cement, and fertilizers will have to wait until free allowances get taken away before those companies get serious about engaging.
Insight 3: In 2026, CBAM will level the playing field for industrial climate tech decarbonising steel, cement, fertilizer and more
There’s one game-changer for tradable goods on the horizon: the Carbon Border Adjustment Mechanism (CBAM), set for 2026. Under CBAM, EU imported industrial goods will have to report supply chain emissions outside EU borders and pay up according to the EU allowance price.
“bye bye” to free allowances This means that even if Tata Steel or Yara moved their manufacturing outside the EU, they would incur the same carbon cost as being part of the ETS, removing the risk of “carbon leakage”. And this means “bye bye” to free allowances.
This is a win for industrial climate tech founders developing technology to decarbonise industry through sustainable heat sources or circular inputs, who will be able to sell their service as a cost saver helping major manufacturers stay cost competitive.
It also levels the playing field for challengers to industrial commodities, such as solutions for green steel, recycled or carbon storage cements, green fertilizers, and alternatives to high emissions commodity imports like palm oil – all of which become more cost competitive once the true cost of carbon is factored into their incumbents.
What Rubio is taking away:
Forget about carbon credit price levels in the EU Emissions Trading System (ETS), both short-term and long-term. What really matters are two things: the shrinking availability of credits and the rules of the EU Commission getting tougher, pushing companies towards decarbonization.
In the coming years, the focus of climate tech founders and investors should be on the sectors that already feel the pain of the ETS system (electricity, paper, etc). This includes Rubio’s investments into the energy space in Sympower, Taylor, RABLE and Amber Electric are helping balance and decarbonise the grid today.
Over the longer term, fueled by CBAM, we see massive opportunities in innovative technologies for hard-to-abate sectors such as Carbon Capture Utilization and Storage (CCUS), green hydrogen, and e-fuels will become indispensable in the sectors that cannot be electrified. Novel furnace technologies (such as Rubio’s investment RIFT) will also be key drivers to provide clean, reliable and affordable energy.
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