The EU Emissions Trading Scheme encourages energy efficiency in the energy and industry sectors by reducing the number of allowances allocated. This leads to stronger incentives for companies to improve carbon and energy efficiency, especially in power production. As a result, demand-side energy efficiency is promoted, with energy and industry sectors being pushed to make greater reductions. However, companies can still rely on credits from the Kyoto Mechanisms, limiting domestic efficiency improvements. In phase 2 of the EU ETS, there are higher incentives for energy efficiency due to increased benchmarking and fewer free allowances allocated. Overall, there is room for improvement to fully realize the potential for energy efficiency in the EU ETS.