Emissions trading

What it means

Emissions trading, known as the EU ETS, is the European Union's main tool for cutting greenhouse gas emissions. It works on the cap-and-trade principle: the EU sets an overall cap on emissions for the sectors covered, divides it into allowances, and each allowance entitles the holder to release one tonne of CO2 equivalent.

The system mainly covers electricity and heat generation, energy-intensive industry such as steel, cement, chemicals and refining, as well as aviation and, since 2024, maritime transport. The cap falls every year, so there are fewer allowances over time and their price tends to rise. A separate system, ETS2, is being set up for buildings and road transport.

Some allowances are given to companies free of charge so they are not disadvantaged against competitors outside the EU; the rest are auctioned. Free allocation is being phased out and replaced by the carbon border adjustment mechanism, which puts a comparable carbon price on imports.

How it works in practice

Most small and medium-sized businesses are not mandatory participants, but they feel the system's effect in the price of electricity, gas, steel, cement or flights. The allowance price feeds into suppliers' costs and they pass it on. When budgeting energy-intensive production, the carbon price should therefore be treated as an ordinary cost item.

A company covered by the system must monitor and report its emissions, have them verified by an accredited verifier and surrender the corresponding number of allowances by the deadline. Each missing tonne attracts a heavy penalty and the allowances must still be bought. The emissions data are also used to calculate the carbon footprint and in ESG reporting.

In Slovak accounting, allowances are carried as a special type of asset. Allowances allocated free of charge are measured at fair value with deferred income recognised at the same time, while purchased ones are measured at cost. The obligation to surrender allowances for actual emissions is recognised as it arises. The details should be checked against the current accounting procedures.

What to watch out for

Allowance prices swing sharply with political decisions, the economic cycle and the weather. A company that needs to buy them should have a purchasing and hedging strategy rather than buying everything just before the surrender deadline. In long-term energy contracts it is worth checking how the carbon price is passed through into the price.

Emission allowances are also a target for fraud, from fake investment offers to cyberattacks on registries. Trade only through verified brokers and exchanges. For companies outside the system, the more common risk is assuming the ETS does not concern them, even though their customers are already asking for data on emissions by scope.