On 17 July, the European Commission unveiled its long-awaited proposal to reform the EU’s core climate policy, the emissions trading system (ETS).
The reform comes after a fierce tug-of-war between those pushing to ease emission-cutting, and those who want to keep legally-binding climate goals within reach.
Those goals include a 2040 target to cut 90% of net EU emissions, and a 2050 net-zero goal.
Since 2005, the ETS sets a yearly cap on how much carbon sectors such as heavy industry, intra-EU aviation and power generation can emit. It makes them buy permits for each ton of carbon emitted. It also sets an annual cap on the maximum emissions allowed.
Unveiling the proposal, which EU countries and MEPs now have to negotiate, Climate Commissioner Wopke Hoekstra said the revised law keeps the EU firmly in line with the 2040 climate goal.
Yet, just hours after it was presented, the Commission’s plan sparked the fury of environmental NGOs, who denounce a weakening of climate ambitions in the name of competitiveness.
Fit for 90% — or not?
A Commission spokesperson said it was “not easy” to precisely determine just how much the ETS will contribute to reaching the 2040 climate target.
The spokesperson estimated that, between its launch in 2005 and 2040, the ETS will cut emissions by 85–87% — with the variation hinging on how much carbon absorption technologies can contribute.
According to these estimates, the ETS should contribute approximately 45% of the total emission reductions needed across all sectors, over the period 1990–2040, for the EU to meet its 2040 goal.
Yet, based on its own modeling, consulting firm Climact said the EU is poised to miss its 2040 target — because the proposed revision would only cut emissions from ETS sectors by 80% in 2040, compared to 2005.
Emissions-cutting predictions are difficult to make, as they rely on carbon prices, themselves dependent on a market in flux. Prices vary due to factors such as the number of emission permits in circulation, the number of those kept in a reserve or handed out for free, or the speed at which the ETS cuts back on the emissions cap each year.
With its proposal, the Commission has moved to ease constraints on all of these parameters, while also pushing ETS industries to invest in decarbonisation — an attempt to strike a delicate balance between climate ambition and industrial competitiveness.
More emission permits
In line with earlier announcements, the Commission proposed slowing down the pace at which the ETS pushes industry to cut emissions each year through 2030. This pace is set by a fixed percentage known as the linear reduction factor (LRF). Currently at 4.3%, the reform proposes to set the LRF at 4.4% in 2028 and at 3.7% from 2031-2035. From 2036 onwards, it would be reduced even further to 1.7%.
These changes mean there will be more emission allowances in circulation. The ETS allowance cap would hit zero somewhere between 2046-2048, rather than in 2039 as currently planned.
The reform also proposes tweaking the market stability reserve (MSR) of the ETS, which is used to balance carbon prices by adding or removing allowances from the market. The proposed changes aim to keep allowances in circulation for a longer period.
Currently, the MSR pulls 24% of all emission allowances in circulation if they top 1.09 million. The reform proposes halving this to 12% — while lowering the triggering threshold to 947 million. Conversely, the reform proposes lowering, from 400 million to 300 million, the lower limit that triggers the release of 100 million additional allowances. It also proposes a yearly, 4% decrease of both the upper and lower limits from 2029.
And more free allowances too
Carbon prices also depend on the number of free carbon allowances granted to industry, such as those going to sectors subject to the carbon border adjustment mechanism (CBAM): iron, steel, aluminium, fertilisers, cement, hydrogen and electricity.
These freely granted permits are designed to prevent industry from relocating production to countries with laxer climate rules.
While the ETS previously provided for a phaseout of these free permits by 2034, the Commission’s reform proposes to reinstate 15% of free permits, from 2028.
The phase-out would then be pushed back to 2038, effectively slowing down the implementation of CBAM and offering some leeway to importers of goods covered by the levy.
From 2021–25, free allowances accounted for, on average, around 85% of emissions from energy-intensive industries. The Commission estimates that, in 2026-2030, this figure will average 78%.
‘No more free cash’
The revision also aims to transform the ETS “into a genuine engine for innovation and investment”, said Hoekstra.
To ensure this, the Commission proposed setting conditions on granting free emission allowances, in a bid to promote investment.
“Free allocation does not mean free cash,” said Hoekstra, highlighting differences from the previous regime.
From 2031, 80% of allowances that companies receive for free will be conditioned on recipients publishing plans for decarbonisation investments. The remaining 20% will only be granted after verifying that the investment led to a significant drop in emissions. Companies can still sell these allowances but, if they relocate outside the EU, they will have to hand the permits back.
Further, free allowances will not be allocated for each factory or power plant. They will be pooled at company level or even shared between different companies.
Tighter spending rules
The Commission wants to ensure that ETS revenues, generated from auctioning emission permits, are used to finance industrial decarbonisation.
EU countries currently allocate on average only 5% of their ETS revenues to such purposes. The revamped law says they must now dedicate at least 50% of these funds to decarbonise ETS-covered sectors.
This change is likely to irk some EU finance ministers, wary of losing control over their national cash.
To kick-start investments, the Commission also plans to launch a new interim financing instrument dubbed the ETS investment booster. Announced for 2027, it will operate based on fixed premiums, and will be funded by 400 million allowances, drawn from a reserve destined for new installations falling under the ETS.
The fund would be primarily aimed at poorer member states. The EU executive will begin consulting on how to implement this in September.
From 2031, the investment booster would be replaced by an Industrial Decarbonisation Bank. This Bank would also be financed by an additional 400 million allowances drawn from the EU-wide pool of permits issued each year. The Commission estimates the bank will have a budget of €100 billion, including the €30bn from the ETS booster.
Long road ahead
The revision of the ETS is but one piece of a larger legislative puzzle currently being developed for the post-2030 period — and thus one of several factors dictating whether the EU will be able to deliver its 2040 climate goal.
Already in December, the Commission plans to update a slew of existing laws crucial for this goal: the Energy and Climate Governance Regulation, the Renewable Energy Directive, and the Energy Efficiency Directive. Legislation covering emissions from sectors outside the ETS, such as forestry and land use, is also expected by the end of 2026.
Yet any ton of CO₂ not snipped by the ETS will have to be offset by other means.
Compensating through additional efforts in other struggling sectors, such as agriculture and transport, could mean tackling prickly subjects like petrol and diesel cars. It’s likely to be “exceedingly difficult”, as some of the countries most supportive of the ETS have already warned.
