EU Proposes Carbon Market Overhaul to Ease Pressure on Industry

The European Commission has proposed a significant overhaul of the European Union Emissions Trading System, seeking to balance the bloc’s climate targets with growing concerns about industrial competitiveness, energy prices and the risk of manufacturing activity moving abroad.

Published on 17 July 2026, the proposed revision would slow the rate at which carbon allowances are removed from the market after 2030, extend free allowances for some industrial sectors and introduce new conditions linking free allocation to investment in European decarbonisation projects.

The Commission says the changes are intended to keep the carbon market aligned with the EU’s legally binding target to reduce net greenhouse gas emissions by 90% by 2040 compared with 1990 levels. However, an analysis cited by Forbes estimates that the revised emissions trajectory could create room for approximately 2.4 billion additional tonnes of carbon dioxide emissions compared with the current framework.

A Slower Reduction in Carbon Allowances

The EU ETS operates under a cap-and-trade system. Power producers, industrial installations, airlines and shipping companies must obtain an allowance for every tonne of greenhouse gases they emit. The overall number of allowances is reduced each year, creating a financial incentive for covered companies to lower their emissions.

Under the Commission’s proposal, the annual reduction in the emissions cap would continue at approximately 4.4% until 2030. It would then fall to 3.7% between 2031 and 2035 and to 1.7% from 2036.

This represents a substantial change from the existing trajectory, which would have continued removing allowances at a faster rate and could have brought the supply of new allowances close to zero around 2039.

The European Parliamentary Research Service has previously warned that an allowance supply approaching zero could reduce market liquidity and increase price volatility. The Commission’s revised trajectory is therefore intended partly to avoid a sudden carbon market “endgame” while allowing a limited level of residual emissions after 2039.

Environmental organisations argue that the slower reduction will weaken the scarcity signal that encourages companies to invest in electrification, renewable energy, hydrogen, carbon capture and other low-carbon technologies. WWF estimates that the slower cap alone could permit around 2 billion tonnes of additional emissions.

Free Allowances Extended Until 2038

The proposal would also extend the phase-out of free carbon allowances for sectors covered by the EU Carbon Border Adjustment Mechanism.

Steel, cement, aluminium, fertiliser, hydrogen and other carbon-intensive industries currently receive some allowances without charge to reduce the risk of carbon leakage. Carbon leakage occurs when production moves to countries with weaker climate requirements, potentially shifting rather than reducing global emissions.

Under the earlier framework, free allocation for CBAM-covered industries was expected to be phased out by 2034 as the border mechanism gradually imposed an equivalent carbon cost on certain imported products. The new proposal would extend that timetable until 2038.

Access to free allowances would become more conditional. Companies would be required to present credible plans for investing in cleaner production within Europe. According to the proposal, businesses could receive 80% of their eligible free allocation after submitting an approved investment plan, while the remaining 20% would be released once the investment had been made.

The Commission argues that these conditions will help prevent free allowances from merely subsidising continued fossil fuel use. They are intended to direct carbon-market support towards industrial electrification, clean hydrogen, energy efficiency, carbon capture and other technologies capable of reducing structural emissions.

Industry representatives have broadly welcomed the additional time but have raised concerns about administrative complexity and uncertainty surrounding the eligibility rules.

Implications for Clean Industrial Investment

The reform could have contrasting effects across European industry.

Operators of conventional steel, cement and chemical plants may benefit from lower near-term carbon costs and a longer period in which to complete expensive industrial upgrades. This could reduce the immediate risk of plant closures or relocation, particularly in sectors already facing high electricity and natural gas prices.

However, companies that invested early on the assumption that carbon allowances would become increasingly scarce may face a weaker competitive advantage.

Hydrogen-based steel projects are frequently cited as an example. Companies developing near-zero-emissions steel production have committed significant capital based partly on expectations that conventional coal-based steelmaking would face progressively higher carbon costs.

If conventional producers continue receiving free allowances for longer and the supply of allowances declines more slowly, the price gap between low-carbon and traditional materials could remain wider than previously expected. This may affect investment decisions, project financing and demand for green industrial products.

The issue is particularly important for first-of-a-kind projects, which generally have higher production costs and depend on predictable climate policy, long-term purchase agreements and public support to reach commercial scale.

Wider Coverage for Waste and Aviation

Alongside the additional flexibility for industry, the proposal would expand the ETS into new areas.

Municipal waste incineration would be brought into the system from 2031. Applying a carbon price to emissions from burning waste could strengthen incentives for recycling, material recovery, waste prevention and improved product design.

The Commission has also proposed extending aviation coverage to more flights within approximately 5,000 kilometres of a central European reference point. This could include additional routes to North Africa and the Middle East.

Private aviation would also be included more fully, closing exemptions that have allowed some private jet operations to remain outside the main carbon-pricing framework.

The revisions would retain the EU ETS’s role as one of the world’s largest and most established carbon markets. Launched in 2005, the system now covers power generation, energy-intensive industry, aviation and maritime transport. Emissions from covered sectors had fallen by approximately half compared with 2005 levels by 2024.

Carbon Market Stability and International Credits

The reforms follow a separate Commission proposal concerning the Market Stability Reserve, which manages surpluses and shortages of allowances.

The Commission has proposed ending the automatic invalidation of allowances held in the reserve above 400 million. Instead, those allowances would be retained as a buffer that could be released if the market experiences severe supply constraints. By the end of 2024, approximately 3.2 billion allowances had already been permanently invalidated.

The ETS proposal would also allow a limited role for high-quality international carbon credits from 2036. These credits could enable part of the EU’s climate target to be met through verified emissions reductions or removals outside the bloc.

Details concerning eligible project types, environmental integrity, monitoring and limits on credit use will be critical. Previous experience with international offsets has raised concerns about additionality, permanence and whether claimed reductions would have occurred without carbon-market finance.

Legislative Negotiations Ahead

The Commission’s proposal is not yet law. It must be negotiated and approved by the European Parliament and the Council of the European Union, representing the 27 member states.

The negotiations are likely to expose divisions between governments seeking more support for energy-intensive industry and countries that want to preserve a strong and predictable carbon price.

For businesses, the proposal creates both additional flexibility and policy uncertainty. Carbon-intensive companies may gain more time to decarbonise, but access to free allowances will increasingly depend on documented investment commitments. Clean-technology developers, meanwhile, will be watching whether the final legislation maintains a sufficiently strong carbon price to support low-emissions projects.

The final design will determine whether the EU can protect industrial capacity while preserving the investment signals needed to reach its 2040 and 2050 climate objectives.

Source: www.forbes.com