Special Topic Four on the Construction and Future Prospects of the Carbon Market: International Benchmarking and Experience from the EU Carbon Market

The European Union Emissions Trading System (EU ETS), as the world's first and largest multinational carbon market, has been in operation for nearly 20 years since its launch in 2005, undergoing four development stages. This system not only provides an effective tool for the EU to achieve its climate goals but also offers rich experiential references for the construction of China's carbon market. Through a systematic analysis of the development process, operational mechanisms, and actual effects of the EU ETS, many policy elements that are enlightening for improving China's carbon market can be extracted. The EU experience shows that the maturity and perfection of the carbon market is a long-term process that requires continuous adjustment and optimization based on the economic environment, emission reduction needs, and market feedback.

The Four Development Stages of the EU Carbon Market

 

The evolution of the EU ETS shows clear phased characteristics, with each stage having its key tasks and institutional innovations. 2005 to 2007 was the first stage: institutional construction phase. This phase was the pilot operation period with the core goal not being immediate significant emission reductions but rather building the carbon market institutional framework and promoting the market-based trading of carbon emission allowances, initially establishing a carbon pricing mechanism. Participating countries included 25 EU member states such as France and Germany, covering industries such as power generation, oil refining, steel, cement, glass, ceramics, and paper which accounted for about 50% of the EU's total carbon dioxide emissions. During this period, countries had autonomy in allowance allocation, with 95% of allowances distributed for free and only 5% allocated through auctions. Due to the nascent market and imperfect system, there was an over-allocation of allowances and excess supply, causing the carbon price to plummet sharply from 22 euros/ton in 2005 to 1 euro/ton in 2007.

2008 to 2012 entered the second stage: volatile adjustment phase. During this phase, the EU linked allowance allocation more closely with emission reduction targets to enhance the effectiveness of the carbon market. Five new member states including Romania, Bulgaria, and Norway joined, bringing the total to 30. The scope of regulation expanded further to include aviation, chemical, and food manufacturing industries, and began to include nitrous oxide (N ₂ O) and other non-CO₂ greenhouse gases. Although the allowance allocation mechanism was optimized, the auction proportion increased to 10% the 2008 global financial crisis severely impacted the real economy, reducing energy demand and emissions, leading to allowance surplus and a carbon price decline from 22 euros/ton in 2008 to 13 euros/ton in 2012.

2013 to 2020 entered the third stage: reform and recovery phase. The EU significantly strengthened institutional unity and market rigidity, centralizing allowance allocation authority at the EU level and ending national autonomous allocation, setting a linear annual reduction rate of 1.74% for total allowances, and raising the auction proportion to 57%, with the power sector even achieving 100% auctioning. After Croatia joined, the total number of member states reached 31, and the regulated gases expanded to include perfluorocarbons (PFCs) with industry coverage extending to petrochemicals and aluminum production. Due to the lingering effects of the financial crisis, carbon prices hovered at a low level of 4–8 euros/ton between 2013 and 2017, but with economic recovery and institutional effectiveness, carbon prices steadily rose from 2018, reaching an average of 23 euros/ton in 2020, restoring pre-crisis levels.

From 2021 to present is the fourth stage: steady development phase. The EU continues to intensify emission reductions, increasing the annual allowance reduction rate to 2.2%, and actively exploring the inclusion of maritime shipping and waste incineration in regulation. After Brexit, the number of member states adjusted to 30. During this phase, carbon prices entered a rapid upward channel, with the average carbon price surpassing 80 euros/ton in 2023, reflecting significantly strengthened market expectations. The EU also uses auction revenues to establish special funds to support low-carbon technology research and development and the green transition of low-income member states, marking the EU carbon market as an important policy tool driving regional carbon neutrality.

Lessons from the EU Experience for China's Carbon Market

 

The development history of the EU ETS provides multiple important references for the construction of China's carbon market. Regarding allowance allocation, the EU experience shows that a gradual transition from free allocation to paid allocation is a feasible path. In the first phase of the EU ETS, free allocation accounted for over 95%, while by the third phase auctions became the main method (57%). China currently mainly uses free allocation and may consider gradually increasing the proportion of paid allocation in the future, but must balance environmental effectiveness with corporate burden and design transition plans suited to national conditions. The Ministry of Ecology and Environment has stated it will "promote the implementation of paid allocation of allowances," which aligns with the EU experience.

Regarding industry coverage, the EU ETS's phased expansion strategy is worth referencing. The EU started with energy and heavy industry and gradually included aviation, petrochemicals, and other sectors, also considering expanding to other greenhouse gases. China's carbon market began with the power generation sector and has now included steel, cement, and aluminum smelting. In the future, it can continue to expand coverage orderly according to the principle of "mature one, include one," while paying attention to coordination and fairness among industries. The timing and method of inclusion for different industries should be based on sufficient technical preparation and impact assessment.

Regarding market stability mechanisms, the EU ETS introduced the Market Stability Reserve (MSR) Effectively addressed the quota supply and demand issue. This mechanism reduces auction volumes when carbon prices are too low, absorbing surplus quotas, enhancing market resilience, and effectively stabilizing carbon prices. As China's carbon market undergoes economic restructuring and renewable energy development, it may also face risks of quota supply and demand imbalance, making it necessary to establish similar market adjustment mechanisms. This requires Accurate assessment of quota supply and demand status and scientifically designing trigger conditions and intervention methods.

Regarding carbon price signals, EU experience shows that a reasonable carbon price is key to driving emission reduction investments. The EU ETS carbon price has gradually stabilized from early fluctuations, maintaining roughly between 50-80 euros/ton in recent years, providing clear guidance for low-carbon investments. China's current carbon price is about 70-80 yuan/ton (approximately 9-10 euros), with significant room for future increase. Enhancing carbon price effectiveness requires comprehensive use of tightening the cap, expanding coverage, increasing paid allocation, and other measures while paying attention to controlling impacts on competitiveness.

In terms of revenue use, the EU's practice of using auction revenues to support green transition is exemplary. The 175 billion euros of auction revenue mainly flows into national budgets, used for renewable energy, energy efficiency improvements, and low-carbon technology investments. If China introduces paid allocation of quotas, it should also clarify revenue use, prioritizing support for low-carbon transition in affected industries and regional coordinated development, enhancing policy acceptability and fairness.

Differentiated Innovation in China's Carbon Market

 

While learning from the EU experience, China's carbon market construction needs to be designed with national conditions in mind. The EU's carbon emissions have entered a declining trend, whereas China is still in a developing stage, facing dual pressures of development and emission reduction. This fundamental difference determines that China's carbon market must pay more attention to balancing environmental goals and economic impacts, adopting a more gradual reform pace.

In terms of institutional linkage, China innovatively established a "mandatory + voluntary" dual-driven model. The national carbon emission trading market (mandatory market) and the national greenhouse gas voluntary emission reduction trading market (voluntary market) "each have their focus and operate independently, yet complement and interconnect." This design draws on international experience while reflecting Chinese characteristics, helping to mobilize broader social forces to participate in emission reduction. The voluntary emission reduction market "supports the development of forestry carbon sinks, renewable energy, methane reduction, energy saving and efficiency projects, and encourages wider industry and enterprise participation in greenhouse gas reduction actions."

The development history of the EU ETS proves that the maturity and improvement of the carbon market is a dynamic process requiring continuous adjustment and optimization based on practical feedback. Although China's carbon market started later, it has developed rapidly and is expected to forge an efficient development path suited to national conditions through learning from international experience and independent innovation. With continuous institutional improvement, expanding coverage, and increasingly standardized operation, China's carbon market will have an increasingly important impact on global climate governance and provide valuable reference for developing countries building carbon markets.

Author:

Zhang Juntao Deputy Secretary-General of China Energy Conservation Association and Secretary-General of the Carbon Neutrality Professional Committee

Ding Haichen Policy Research Officer of the Carbon Neutrality Professional Committee, China Energy Conservation Association