The EU’s carbon market enters its competitive era

After months of anticipation, the Commission finally showed its hand on 17 July, unveiling a proposed overhaul of the EU Emissions Trading System (EU ETS) designed to keep Europe’s climate ambitions on track without placing industry under further strain.

The package is the first instalment in a broader set of initiatives designed to strengthen Europe’s economic resilience and competitiveness while keeping the EU on track to meet its legally binding 2040 target of cutting net greenhouse gas emissions by 90%. The review arrives in a markedly different geopolitical and economic landscape, shaped by the energy-market disruption following Russia’s invasion of Ukraine and mounting pressure on European industry.

The aim is to prepare the ETS for the next phase of the transition, preserving its role as a market-based, technology-neutral and economically efficient instrument on the road to climate neutrality by 2050.

So, what’s actually changing?

Brussels is seeking to keep the ETS at the heart of EU climate policy while adapting it to the industrial realities of the journey towards 2040. One of the central changes concerns the post-2030 emissions-reduction pathway, which would become more gradual under a revised Linear Reduction Factor. The proposal also introduces limited flexibility through the use of high-quality international carbon credits.

Up to 2% of emissions reductions between 2036 and 2040 could be delivered through projects outside the EU, giving Europe a little more room to maneuver while supporting climate action beyond its borders.

From carbon pricing to industrial investment

At the heart of the reform is a stronger investment dimension, with the Commission aiming to reinforce the role of the ETS as a driver of industrial transformation rather than only a carbon pricing mechanism. The proposed Industrial Decarbonisation Bank, backed by €100 billion, together with the ETS Investment Booster and the Innovation Fund, would support the deployment of clean technologies and large-scale industrial decarbonisation projects.

In parallel, Member States would be required to reinvest 50% of their ETS revenues into decarbonisation investments in ETS sectors.

This investment-oriented approach also reshapes the future of free allocation. While free allowances will continue beyond 2030, they will become increasingly linked to companies’ decarbonisation efforts, with the objective of directing industrial support towards those investing in the transition. The proposal also introduces permanent carbon removals into the ETS framework, providing additional flexibility for hard-to-abate sectors while supporting the development of carbon removal technologies.

Finally, the Commission seeks to address competitiveness concerns through targeted adjustments to existing mechanisms. Revised benchmarks would increase free allocation for industry by around €6 billion between 2026 and 2030, while the phase-out of free allowances for CBAM-covered sectors would be extended until 2038. At the same time, reforms to the Market Stability Reserve aim to improve predictability and reduce excessive price volatility.

The revision also strengthens the role of the ETS in aviation and maritime transport, extends its scope to waste incineration and aims to ensure greater consistency with international developments.

The political battle lines take shape

The Commission’s ETS revision was among the most politically sensitive files expected under the new mandate. The debate surrounding the future of the carbon market had already intensified in the months preceding the proposal, with several Member States calling for adjustments to the post-2030 architecture. A group led by Italy had pushed for a substantial revision of the current framework, arguing that the existing trajectory could increase pressure on European industry and weaken competitiveness.

Other Member States, including Sweden, Denmark and the Netherlands, have traditionally defended the ETS as the cornerstone of EU climate policy, while remaining open to targeted adjustments aimed at strengthening investment capacity without compromising the environmental integrity of the system.

With the Commission’s proposal now on the table, the political debate is set to move into a new phase. The first reactions from political groups reveal a broad consensus on the need to preserve the ETS as the EU’s central climate instrument, but significant differences emerge over how far the system should be adapted to address industrial concerns.

The European People’s Party (EPP) broadly welcomed the proposal as a balanced compromise between climate objectives and industrial competitiveness. The group highlighted the slower post-2030 emissions reduction trajectory, the extension of free allocation under CBAM and the stronger link between free allowances and decarbonisation investments as key elements to provide industry with greater certainty and time to invest in the transition.

Peter Liese, the EPP rapporteur on climate policy, argued that the proposal could support both climate protection and European jobs by reducing the risk of carbon leakage.

Too much for some, too little for others

The S&D and Renew Europe groups adopted a more cautious stance, warning that some elements of the reform could weaken the long-term carbon price signal. Mohammed Chahim and Tiemo Wölken from S&D welcomed the stronger investment dimension of the proposal, including the Industrial Decarbonisation Bank and the link between free allocation and decarbonisation efforts, but criticised the slower reduction trajectory, the extension of free allowances and the use of international credits, arguing that these measures could weaken incentives for domestic action. They also called for stronger social conditions attached to industrial support.

Renew Europe’s Pascal Canfin similarly supported measures aimed at boosting investment but considered some elements of the proposal a step back in terms of climate ambition, particularly the extension of CBAM-related free allocation until 2038, which he argued could undermine the credibility of the carbon border mechanism.

ECR Co-Chair Nicola Procaccini considered the slower emissions reduction trajectory after 2030 a first step, but argued that the proposal does not go far enough in addressing the pressures faced by European industry.

He called for a broader revision of allowance availability and benchmark rules, arguing that existing benchmarks do not always reflect the technological limits reached by companies that have already achieved high levels of energy efficiency.

A high-stakes road to 2027

The legislative process of the ETS revision will be shaped by political divisions within the European Parliament, differing positions among Member States and the interests of sectors directly affected by the carbon market.

The three legislative proposals will follow the ordinary legislative procedure, requiring agreement between the European Parliament and the Council. Parliamentary work is expected to begin in the coming months, with the responsible committees for each file expected to be identified in September.

Initial appointments indicate that the ETS Directive file will be closely followed by key political figures. German MEP Peter Liese has already been designated rapporteur for the EPP, while Michael Bloss has been appointed rapporteur for the Greens.

Under the objectives outlined in the “One Europe, One Market” roadmap, the European Commission, the Council and the European Parliament aim to conclude negotiations on the package by the first quarter of 2027. The outcome of the legislative process will determine how the EU balances the need to maintain climate ambition with the growing pressure to strengthen industrial competitiveness and investment capacity.