EU Commission Proposes Reform of EU Emissions Trading System

Relief for industry and new incentives for decarbonization – renewed momentum or brake for climate action?

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In mid-July, the European Commission put forward a proposal for a targeted revision of the mandatory EU Emissions Trading System (EU ETS). The proposed reform aims to strengthen European industry’s competitiveness while still supporting the achievement of the EU’s 2040 climate targets. The measures under consideration include:

·        a slower reduction of the emissions cap,

·        additional funding for industrial decarbonization,

·        revised rules for the free allocation of emissions allowances

·        new mechanisms for international carbon credits and permanent carbon removals.

First Climate read through the reform proposal and put together some of the key elements and their possible implications for companies.

Slower Reduction of Emissions Cap

The total amount of EU ETs available emissions allowances is still expected to decrease, only slower than originally planned. Under the proposal, the annual reduction factor would be set at 3.7% between 2031 and 2035 and at 1.7% starting in 2036, onwards.  

As a result, more free allocations of emissions allowances would remain in the market than under the original reduction pathway. This could limit price pressures and provide short-term relief, particularly for energy-intensive companies. However, the actual price development is dependent on the economic conditions and the emissions of the sectors covered by the system. There is also the risk that lower prices could also weaken motivation to decarbonize.

More Funding for Industrial Decarbonization

The proposal also puts forward substantial funding for the industrial transition, including through the creation of a new bank specifically for industrial decarbonization and innovation funds. The proposed “Industrial Decarbonisation Bank” would make up to100 billion euros available for decarbonization projects. An additional “Investment Booster” would support initial investments before 2030.

In addition to this, Member States would be required to direct at least 50% of ETS revenues back into industrial decarbonization.

Under the proposal, companies would only be eligible for the free allocation of ETS emissions allowances if they can demonstrate approved decarbonization investment plans. The free emissions allowances would be more closely linked to concrete and verifiable transformation measures.

Use of International Carbon Credits Starting in 2036

From 2036 onwards, high-quality international carbon credits are also expected to play a limited role in the EU ETS. Their purchase would be financed through the sale of up to 260 million EU emission allowances and carried out via a centralized procurement mechanism. The specific quality and eligibility criteria are to be defined at a later stage.

Carbon Dioxide Removals (CDR) Enter the EU ETS for the First Time

The proposal also introduces a dedicated mechanism for permanent carbon removals within the European Union. For the first time, permanent carbon removals certified under the EU Carbon Removals and Carbon Farming (CRCF) Regulation would be integrated into the EU ETS.

This would create an initial market pathway for selected EU-based carbon removal technologies. It could strengthen demand for European CDR solutions such as DACCS and BECCS and become particularly relevant for hard-to-abate sectors, including highly energy-intensive industries.

Changes for Aviation and CBAM Sectors

In the aviation sector, the European Commission continues to support the Carbon Offsetting and Reduction Scheme for International Aviation (CORSIA). One potential change is that, from 2029, the EU ETS would be extended to cover additional flights departing from the European Economic Area for destinations outside Europe. The EU also intends to provide further support for sustainable aviation fuels.

The phase-out of free allocation for sectors covered by the Carbon Border Adjustment Mechanism (CBAM) is also expected to be slowed. A portion of the free allocation would remain in place until 2037 and would only be fully phased out in 2038.

Reforming the Market Stability Reserve

The European Commission is also proposing a revision of the Market Stability Reserve (MSR). Specifically, mechanisms such as the automatic cancellation of surplus allowances could be adjusted or suspended, allowing more allowances to remain in the system and helping to mitigate price spikes in the carbon market.

This would reduce price pressure and provide industry with greater planning certainty and relief during the transition. At the same time, however, a persistently high supply of allowances could weaken the carbon price signal and delay necessary investment in climate action.

First Climate’s Perspective

“We welcome the European Commission’s focus on strengthening Europe’s competitiveness. However, it would be a mistake to assume that Europe can afford to slow the pace of climate action. Every emission reduction that is delayed today will have to be achieved later under greater time pressure and at higher cost.

If mandatory requirements are tightened more slowly, voluntary corporate action becomes even more important. However, companies that are already taking action cannot be expected to close a political ambition gap on their own. Voluntary climate finance must complement, rather than replace, consistent decarbonization and an ambitious regulatory framework.

Allowing carbon removals to be recognized within the EU ETS is a necessary and long-overdue step. However, if the Commission restricts access to niche technologies that are currently far from being commercially viable, it risks leaving enormous potential untapped. What is needed is genuine technology neutrality and the inclusion of solutions such as biochar, which can be deployed immediately and contribute to climate action today,” comments Wolfgang Brückner, Managing Director of First Climate Project Development (First Climate Projektentwicklung GmbH).

The European Commission’s reform proposal will now be submitted to the European Parliament and the Member States for consideration and approval. We will keep you informed of further developments.

What Is the European Union Emissions Trading System?

The EU ETS is a mandatory cap-and-trade system. The European Union sets an overall limit on emissions from the sectors covered by the system.

Companies must surrender a corresponding number of EU emission allowances for their verified emissions. Each allowance represents the right to emit one tonne of CO₂ equivalent. EU emission allowances are not the same as voluntary carbon credits. As the total number of allowances is gradually reduced, a carbon price is created, providing an economic incentive to reduce emissions.