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Carbon – In focus: All eyes on the EU ETS review

Carbon – In focus: All eyes on the EU ETS review

London, 10 July (Argus) — The European Commission is set to present its review of the EU emissions trading system (ETS) on 17 July, which some argue could be a defining moment for European climate and industrial policy. The review has been a key driver of the ETS market in recent months and has triggered intense lobbying by member states, industry groups, politicians and civil society organisations, as the bloc seeks to balance a realistic industrial decarbonisation pathway with its broader climate targets. Among the most significant changes under consideration is an extension of the ETS cap trajectory — which was expected to reach zero by 2039 — but will now see allowances being issued "well into the 2040" – as the commission has repeatedly said since mid-May . This would require a lower linear reduction factor (LRF), which determines the annual rate at which the emissions cap declines. The LRF is currently set at 4.3pc for 2024-27 — after being increased from 2.2pc in 2021-23 — and 4.4pc from 2028. Although the commission has not specified a revised rate, it has indicated that the LRF cannot be reduced too "drastically" in order to not "penalise the frontrunners", an EU official said on 8 July . Some stakeholders have opposed such changes, arguing that the emissions cap should remain broadly aligned with its current trajectory at least until 2036. An LRF below 4pc would "dramatically" weaken the business case for industrial decarbonisation and would shift an unrealistic share of the emissions reduction burden onto sectors outside the ETS, such as agriculture, Greg van Elsen, senior policy coordinator for industrial policy at Climate Action Network (CAN), told Argus . Others expect the LRF to be reduced midway between the previous 2.2pc and the current 4.3pc values. Reducing the LRF to around 3.4pc — a level previously floated by the centre-right European People's Party (EPP) — would align the EU more closely with an 85pc emissions reduction from 1990 levels rather than the overall 90pc target for 2040, climate policy think tank Sandbag's executive director Adrien Assous told Argus . The EU's revised climate law commits the bloc to reduce its greenhouse gas emissions by 90pc by 2040 against 1990 levels, with flexibility to use international carbon credits for up to 5pc of this target. This creates a mandatory domestic reduction component of 85pc, which has often been used as guidance to build possible scenarios for the LRF and other aspects of the ETS that will be reviewed. Research body Oeko-Insitut assumed an LRF of 3.2pc for 2031-35 and 2.2pc from 2036 in a study published in May, finding that this would result in supply of allowances that would significantly exceed demand in the next decade. The study also assumed the ETS cap would reach 290mn permits by 2040, in line with a domestic emissions reduction target of 85pc compared with 1990 levels. MSR changes a mere "tweak" The review will also consider changes to the system's market stability reserve (MSR), which aims to prevent market shocks from oversupply or shortages of ETS allowances (EUAs) by adjusting auction volumes. The commission clarified earlier this week that any modifications to the MSR will remain rule and volume-based, rather than it be triggered by price levels. This could involve adjusting the mechanism's thresholds, which determine when allowances are released from the reserve. Industry specialists see the changes to the MSR as more of a "tweak" than an overhaul, stressing that the changes proposed would most likely only make the mechanism more reactive to changing market conditions and would not disrupt the market's supply-demand balance. The MSR proposal complements a separate commission initiative announced in April, which would stop the automatic cancellation of ETS allowances and retain permits held in the MSR above the current 400mn threshold. That proposal will now also be assessed alongside the broader ETS review. Support to industries Many of the issues addressed in the review are intended to give European hard-to-abate industries more flexibility in meeting their ETS obligations, although the commissions has suggested support could be subject to certain conditions. The review aims to strengthen the ETS' ability to support investment in hard-to-abate sectors and to ensure that decarbonisation drives competitiveness by rewarding heavy industries that have made the "necessary" investments. To achieve this, the commission is considering measures such adjusting the phasing out and scope of free allowances, ensuring a certain share of ETS revenues to member states is fed back into decarbonisation projects under ETS sectors, establishing mechanisms to speed up investments in industrial decarbonisation, and integrating carbon removals to help offset emissions from the most difficult-to-abate sectors, among other options. Free allowances to boost supply Additional supply is likely to enter the market as a result of these proposals , particularly through increases to the free allocation of allowances. The commission is considering a slower phase-out of free allocation for ETS sectors with a higher risk of carbon leakage — those covered by the carbon border adjustment mechanism (CBAM) — beyond the current 2034 end date. This would result in additional free EUAs being granted after 2034, although no extra allocation would be issued before then, an EU official clarified on 8 July. This is the aspect of the review that Sandbag told Argus is the most concerning. The think tank argues that European producers in CBAM-covered sectors would have a weaker incentive to cut emissions, and should they receive additional free allowances, they could even make profit from the system, Assous said. Extending free allocation would also disadvantage companies that have already invested billions of euros in decarbonisation to avoid future carbon costs, Carbon Management Europe (CME) — the commission's adviser on industrial carbon management — said in a position paper published on 7 July . "Delaying the phase-out of free allocation would send the message to every future investor that the EU's climate commitments are negotiable", CME's policy adviser Konstantin Philipp told Argus . Alongside the broader ETS review, the commission is also expected to propose a separate legal act on sector-specific fallback benchmarks , which are used to calculate free allocations when product-specific carbon-intensity benchmarks are unavailable. The measure is intended to address concerns raised by several industrial sectors. If approved, it could result in around €6bn worth of additional free EUAs being allocated to industry for the remainder of ETS' phase 4, which ends in 2030. More revenues "reserved" for ETS payers The commission will also propose that a minimum share of the system's revenues allocated to member states are redirected towards decarbonisation efforts in ETS-compliant sectors. Some participants view this as the "most problematic" aspect of the reform, arguing it is likely to find resistance from many member states. According to commission data, 78pc of historical ETS revenues have flowed into national budgets, while only 5pc has been spent on industrial decarbonisation. Since 2023, member states have been required to direct all ETS revenues towards climate and energy-related purposes, although there are still large amounts going to programmes that may not be directly aimed at reducing emissions. Investment booster The commission is also set to launch its €30bn clean energy investment booster in 2027. The programme will be financed through 400mn EUAs and will reward companies based on their progress in reducing emissions. Funding will be distributed on a first-come, first-serve basis, the commission said on 8 July . The booster will be the first phase of the €100bn industrial decarbonisation bank (IDB), which will provide financial support for hard-to-abate sectors — particularly in lower-income member states — to build a bankable case for industrial decarbonisation. The €30bn intended for the booster will be given on a "first-in, first-serve" basis, to enable a speedy allocation of funds to industrial companies. The commission has said applications will be subject to simplified assessments with light eligibility checks, submitted on a rolling basis, while payments will be made upon verified emissions reductions. In the second phase, the IDB will introduce a more competitive project selection process, including the use of carbon contracts for difference awarded through competitive bidding. Removals integration in the ETS The commission is also mulling integrating carbon dioxide removals into the ETS, in a bid to create "extra emission space" for hard-to-abate sectors while also helping create demand to "kickstart and scale-up" the removals sector. It has indicated that any integration would be limited to permanent, domestic removals certified under the bloc's carbon removals and carbon farming (CRCF) regulation. These currently include direct air capture and carbon storage (Daccs), biogenic emissions capture with carbon storage (Beccs) and biochar carbon removals. The commission is still considering the best way to implement the removals' integration and has outlined three potential options: a public authority could purchase removal credits and manage them through a central pool; operators could purchase the credits individually; or, companies could meet part of their compliance obligations by using removal credits under a "one-for-one" offsetting principle. Regardless of which option the commission goes for, the integration of removals is expected to loosen up supply or destroy some demand for EUAs, eventually having a downside impact on prices. That said, removal credits currently trade at a significant premium to EUAs, which might offset some of this downward pressure. The commission has been heavily criticised by some participants for not including nature-based removals for ETS integration. The International Emissions Trading Association (IETA) said in a position letter on published on 3 July that the EU should also provide a compliance pathway for nature-based removals, arguing that a mix of engineered and nature-based solutions could help scale the removals sector while supporting the bloc's climate objectives. Others remain sceptical. Integrating removals into the ETS too soon could weaken the carbon price signal at a time when it is beginning to influence long-term decarbonisation decisions, CAN said. Some NGOs have similarly warned that allowing removals into the system could undermine incentives for direct emissions reductions. Some stakeholders have suggested that removal credits should only be introduced after 2036, allowing them to offset emissions from the hardest-to-abate sectors once EUA supply becomes increasingly scarce. The commission is also preparing a separate assessment of how international carbon credits might fit into the framework. It has already made clear that the direct use of international credits for ETS compliance — previously permitted under earlier phases of the system — will not return. Sectoral expansion Broadening the ETS to cover additional sectors could make a "valuable contribution" to achieving net-zero emissions while improving the efficiency of existing carbon markets, IETA said. Such expansion would support compliance demand for EUAs in the coming years. The commission's consideration to expand the scope of the ETS to international aviation and municipal waste incineration could boost compliance demand for EUAs. The commission is assessing whether, and how, to bring international aviation emissions into the scope of the ETS. While intra-European flights have been covered by the scheme since 2012, the bloc wants to address the "unlevel playing field for EU airlines" by applying an "effective" carbon price signal to the EU share of emissions from extra-EEA flights, officials have said. The commission has also indicated it may reduce ETS obligations where the carbon offsetting and reduction scheme for international aviation (Corsia) applies. Sandbag's Assous suggested the EU could also reintroduce aviation-specific allowances (EUAAs), which were delisted from primary market auctions in 2025 but could become "highly valuable" from a surge in demand. He suggested airlines could meet their obligations by surrendering EUAAs alongside a limited share of EUAs, arguing that this would avoid placing a price burden on stationary installations, which are generally more exposed to carbon leakage and rely on EUAs for compliance. The commission is also considering extending international maritime coverage under the ETS to certain smaller ships. This would establish a level playing field with larger vessels, the commission has argued, which have already been included in the system. It has also said it could propose a "gradual" expansion to municipal waste incineration, leaving agriculture as the only major economic sector not subject to carbon pricing after 2030. But even considering the range of measures under consideration, the upcoming review will most likely be a "tweak" of the system rather than a major reform, Gabrielle Kinder, carbon research lead at the London Stock Exchange Group, told Argus . Much of the uncertainty surrounding the review stemmed from concerns earlier this year that it could become an "existential" reform of the ETS rather than a technical update, she said. Several political actors at the time had called for the system to be "suspended" or "postponed", which led to panic in the market and an eventual sellout. Compared with the previous reform in 2021, the current review appears more focused on improving the effectiveness of the existing framework, other sources told Argus . Nevertheless, concerns remain among stakeholders who fear the proposals could weaken the bloc's climate policy. "This is the worst possible time to weaken [the ETS]", CAN's van Elsen told Argus , adding that "this is a make-or-break moment for the EU's ambition to get rid of the fossil fuels that are wrecking both our climate and our economies." Following publication of the review on 17 July, the European Parliament, Council and Commission are expected to negotiate and agree on the proposed reforms by the first quarter of 2027, with implementation planned for 2028. By Kiara Campagne Nieva Send comments and request more information at feedback@argusmedia.com Copyright © 2026. Argus Media group . All rights reserved.