What is a carbon credit?

A carbon credit (also called a carbon allowance or carbon offset) represents authorisation to emit one tonne of CO2 (or CO2-equivalent GHG). In a compliance market (like the EU ETS), an emitting company must surrender one EU Allowance (EUA) for every tonne of CO2 it emits. If it emits less than its allocated allowances, it can sell surplus credits; if it emits more, it must buy additional credits. The carbon price (price per tonne CO2) creates a financial incentive to reduce emissions. In voluntary carbon markets, companies buy offset credits from carbon reduction projects (forestry, renewable energy, methane capture) to compensate for emissions they cannot eliminate — though the integrity of voluntary offsets has been heavily scrutinised.

How does the EU ETS work?

The EU Emissions Trading System (EU ETS) is the world's largest carbon market, covering approximately 40% of EU GHG emissions from power generation, heavy industry (steel, cement, aluminium, chemicals, oil refining), and aviation within the EU. How it works: (1) The EU sets an annual cap on total CO2 emissions from covered sectors — the cap declines each year (the 'cap and trade' mechanism); (2) Allowances (EUAs) are distributed to covered companies — partly via free allocation (declining over time), partly via auctioning; (3) Companies must surrender EUAs equal to their verified annual emissions; (4) If a company emits less than its allowances, it can bank or sell surplus; if more, it must buy; (5) The EUA price is set by market supply and demand. EU ETS Phase 4 (2021–2030) targets a 62% emission reduction below 2005 levels. EUA prices in 2026: approximately €55–80/tonne.

How does the EU ETS carbon price affect fuel prices?

The EU ETS affects fuel prices through two channels: (1) Electricity costs — EU power generators must buy EUAs for coal and gas generation; at €60–80/tonne CO2, this adds approximately €25–40/MWh to gas-fired electricity generation costs, flowing through to industrial and consumer electricity bills; (2) Refinery operating costs — EU refineries are ETS-covered; at €60–80/tonne CO2, refinery CO2 costs add approximately €5–15/tonne of refined product to operating costs, though free allocation partially offsets this; (3) ETS2 for road transport fuels (from 2027) will directly add a carbon price component to petrol and diesel pump prices — estimated €0.09–0.19/litre initially at €40–80/tonne CO2. The EU ETS and ETS2 together are the primary regulatory mechanisms driving the carbon component of European energy costs.

Carbon Credit

A tradeable permit representing the right to emit one tonne of CO2-equivalent greenhouse gas — the mechanism through which carbon pricing internalises climate costs into energy, industry, and transport economics.

Definition

A carbon credit (EU terminology: EU Allowance / EUA) represents authorisation to emit one tonne of CO2 or CO2-equivalent greenhouse gas. Carbon credits are the currency of emissions trading systems (ETS), designed to put a price on carbon emissions that forces emitters to either reduce emissions or pay for the right to continue emitting.

There are two distinct markets:

Compliance markets: Legally mandated; companies must surrender credits equal to their verified emissions. The EU ETS is the world's largest. Others include California's cap-and-trade, China's national ETS, UK ETS.
Voluntary carbon markets (VCM): Companies or individuals voluntarily purchase carbon offset credits from verified projects (forestry, renewable energy, methane capture) to "offset" emissions they cannot eliminate. Voluntary credits have faced significant integrity challenges.

For the policy context driving carbon market expansion, see our COP31 2026 event preview. For shipping's inclusion in EU ETS, see our shipping decarbonisation 2026. For ETS2 effects on road fuel prices, see our EU Energy Week 2026.

EU ETS: the world's largest carbon market

Feature	EU ETS Phase 4 (2021–2030)
Coverage	Power generation, heavy industry, aviation (EU flights), shipping (from 2024)
Annual cap reduction	4.3% per year (from 2024); 4.4% from 2028
Emission reduction target	62% below 2005 levels by 2030
Allowance distribution	Majority auctioned; some free allocation (declining); benchmarked to best-performer
EUA price (2026)	~€55–80/tonne CO2
Market stability reserve (MSR)	Removes surplus allowances from market to support price
Sectors NOT covered (→ ETS2)	Road transport, buildings (→ ETS2 from 2027)

At €70/tonne CO2, the EU ETS adds approximately:

~€25–35/MWh to gas-fired electricity generation costs (natural gas ~0.20 tonne CO2/MWh)
~€45–60/MWh to coal-fired generation (coal ~0.35 tonne CO2/MWh) — making coal uncompetitive vs gas at EUA >€40/tonne
~€5–12/tonne refined product to refinery operating costs (partially offset by free allocation)

ETS2: carbon pricing for road transport and heating

ETS2, the EU's second emissions trading system covering road transport fuels and building heating, is the most directly relevant carbon market for fuel prices:

Start: Allowance auctions from 2026; compliance obligation from 2027
Mechanism: Fuel distributors and importers must surrender ETS2 allowances for CO2 content of petrol, diesel, and heating oil sold in the EU
Price cap: Safety valve at €45/tonne CO2 for the first years (to prevent excessive burden during introduction)
Fuel price impact: ~€0.09–0.19/litre petrol and diesel initially; rising with the carbon price over time
Social Climate Fund: €86.7bn (2026–2032) to compensate vulnerable households

Voluntary carbon market integrity crisis
The voluntary carbon market (VCM) experienced a significant credibility crisis in 2023–2024 following investigative journalism revealing that many forest carbon offset projects (particularly REDD+ credits from Verra's VCS standard) claimed carbon reduction that did not actually occur. Studies showed that some projects' "avoided deforestation" baselines were set artificially high, making the offset credits largely fictional. This triggered a major VCM reform push: The Integrity Council for the Voluntary Carbon Market (ICVCM) launched its Core Carbon Principles (CCPs) to set minimum integrity standards. The VCMI (Voluntary Carbon Markets Integrity Initiative) published claims codes for corporate buyers. High-integrity credits (direct air capture, biochar, enhanced weathering with permanent removal) attract premium prices ($100–400/tonne) vs. nature-based avoidance credits ($5–20/tonne). Companies increasingly distinguish between "removal" and "avoidance" credits in their net-zero claims.

Carbon pricing mechanisms globally

Mechanism	Country/region	Price (approx., 2026)	Coverage
EU ETS (Phase 4)	EU + EEA + UK ETS linked	€55–80/tonne	Power, industry, aviation, shipping
UK ETS	UK	£40–65/tonne	Power, industry, aviation
California cap-and-trade	California + Quebec	$30–45/tonne	Power, industry, transport fuels
China national ETS	China	~¥60–90/tonne (~$8–13)	Power sector only; expanding
Canada carbon pricing	Canada	CAD 65–80/tonne (~$48–60 USD)	Fuel charges + OBPS for industry
Norway CO2 tax + ETS	Norway	~NOK 1,100–1,200/tonne (~€90–100)	Upstream oil, transport fuels

For Norway's high carbon cost in the context of Nordic fuel prices, see our Denmark fuel prices 2026 (which includes a Nordic comparison). For the fiscal breakeven impact on oil producers facing carbon pricing, see our fiscal breakeven glossary entry.

Frequently asked questions

What is a carbon credit? A carbon credit (EU: EUA — EU Allowance) represents authorisation to emit one tonne of CO2-equivalent GHG. In compliance markets (EU ETS, UK ETS, California), companies must surrender credits equal to verified emissions — creating a financial incentive to reduce emissions. In voluntary markets, companies buy offsets from verified reduction projects; VCM integrity has faced significant scrutiny since 2023.: A carbon credit (EU: EUA — EU Allowance) represents authorisation to emit one tonne of CO2-equivalent GHG. In compliance markets (EU ETS, UK ETS, California), companies must surrender credits equal to verified emissions — creating a financial incentive to reduce emissions. In voluntary markets, companies buy offsets from verified reduction projects; VCM integrity has faced significant scrutiny since 2023.
How does the EU ETS work? The EU ETS covers ~40% of EU GHG emissions (power, heavy industry, aviation, shipping). An annual cap on total emissions declines 4.3% per year (Phase 4). Companies receive/auction allowances (EUAs); must surrender one EUA per tonne CO2 emitted. EUA price ~€55–80/tonne in 2026. Target: 62% emission reduction below 2005 levels by 2030. ETS2 extends carbon pricing to road transport fuels from 2027.: The EU ETS covers ~40% of EU GHG emissions (power, heavy industry, aviation, shipping). An annual cap on total emissions declines 4.3% per year (Phase 4). Companies receive/auction allowances (EUAs); must surrender one EUA per tonne CO2 emitted. EUA price ~€55–80/tonne in 2026. Target: 62% emission reduction below 2005 levels by 2030. ETS2 extends carbon pricing to road transport fuels from 2027.
How does the EU ETS carbon price affect fuel prices? EU ETS at €60–80/tonne CO2 adds ~€25–40/MWh to gas electricity costs (flowing to consumer bills) and €5–12/tonne to refinery products. ETS2 (from 2027) will directly add ~€0.09–0.19/litre to petrol and diesel pump prices in the EU. Norway's CO2 tax (~€90–100/tonne) is the highest carbon cost in Europe and contributes to Norway having Europe's most expensive petrol prices.: EU ETS at €60–80/tonne CO2 adds ~€25–40/MWh to gas electricity costs (flowing to consumer bills) and €5–12/tonne to refinery products. ETS2 (from 2027) will directly add ~€0.09–0.19/litre to petrol and diesel pump prices in the EU. Norway's CO2 tax (~€90–100/tonne) is the highest carbon cost in Europe and contributes to Norway having Europe's most expensive petrol prices.