Linear Reduction Factor

The linear reduction factor (LRF) is the annual percentage by which the total emissions cap in an absolute cap-and-trade scheme is reduced. It was first codified in the EU Emissions Trading System and has become the standard mechanism for ensuring a scheme delivers progressively tighter constraints on emissions over time.

How it works

At the start of each compliance period, the cap is multiplied by (1 − LRF/100). A 2 % LRF means the cap shrinks by 2 percentage points each year relative to the previous year's cap. Over a decade, a 2 % LRF applied to a 100 Mt cap would reduce it to roughly 82 Mt — a cumulative reduction of ~18 %.

Why it matters

A fixed cap with no LRF eventually becomes non-binding as abatement technologies improve or economic activity falls. The LRF keeps the cap tight enough to remain a binding constraint and sends a credible long-run price signal to investors considering low-carbon capital expenditure.

EU ETS example

The EU ETS started with an LRF of 1.74 % per year in Phase 3 (2013–2020), raised to 2.2 % in Phase 4 (2021–2030), and is planned to increase further to 4.3 % from 2024 onward under the Fit for 55 reforms.

In the simulator

In Absolute cap mode you can set the LRF (default 2 %). A higher LRF creates a faster-tightening cap, which typically raises allowance prices in later periods and rewards firms that invest early in abatement.