The EU sets an upper limit (cap) up to which CO2 may be emitted. For every tonne of CO2 that a company emits, it must be able to show an emission allowance, a so-calledEUA (European Union Allowance). One EUA entitles a company to emit one tonne of CO2 into the atmosphere.
The amount of EUAs issued by the EU depends on the level of the cap. Thus, the emission target is determined from the outset by the quantity issued. The lower the cap, i.e. the fewer EUAs in circulation, the higher the value attached to an EUA and the incentive to invest in climate-friendly, i.e. low-CO2 technology.
EUAs are tradable, i.e. the price of the certificates is determined by the interplay of supply and demand. For companies with low CO2 avoidance costs, it may be a good idea to sell surplus EUAs on the market. On the other hand, companies whose costs for avoiding one tonne of CO2 exceed the price of an EUA can buy additional allowances on the market. In this way, CO2 is saved exactly where it is possible from an economic point of view at the lowest cost.