The European Union Emissions Trading Scheme (EU ETS), operating since January 2005, demonstrates that it is possible to create a market for carbon dioxide (CO 2 ) even when there is a degree of confusion and chaos in the initial allocation and implementation process. Through this emissions trading scheme, the Ehas succeeded in producing a price signal—via the trading price for European Union Allowances (EUAs)—that does, in some limited sense, reflect the scarce capacity of the earth's atmosphere to absorb more greenhouse gas emissions. This paper focuses on the key factors that have influenced the development and functioning of the EUA market. We first describe the institutional and legal framework for the EU ETS, the scheme's main design features and provisions, and how these factors are likely to affect the EUA market. Next, we discuss how the EUA market has developed and operated since the establishment of the EU ETS. In particular, we describe the intermediaries that have entered the market to facilitate EUA trading, and how the size and frequency of trades have changed over time; identify the key factors that appear to have affected EUA prices; and discuss the trends in EUA trading volumes and prices. The paper also discusses the outlook for the EU ETS in the Kyoto Phase and beyond.
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