ETS-Review: The Foundations of Emissions Trading Must Remain Intact

The European Commission is today presenting its long-awaited proposals to amend the EU Emissions Trading Scheme in the energy, industry, aviation and shipping sectors (EU ETS1). It is becoming apparent that, during the forthcoming legislative process, the Member States, the European Parliament and numerous interest groups will be involved in a fierce battle over lowering the level of ambition for CO₂ pricing. The debate will centre on a slower reduction in the volume of new allowances issued from 2030 onwards and the free allocation of allowances to sectors at risk of carbon leakage.

In order not to undermine the effectiveness of emissions trading as an efficient climate protection tool, further interventions in the market design must be prevented. This applies in particular to adjustments that weaken the price mechanism, which is central to the system’s efficiency. For instance, the introduction of a dynamic price cap by redesigning the market stability reserve has been discussed. Moreover, the free allocation of allowances to industrial companies could be made conditional on investments in decarbonization.

A combination of price cap and investment conditionality would jeopardize the viability of the emissions trading system, which relies heavily on price expectations. The expectation of rising CO₂ prices in the long term remains crucial to the financial viability of investments in climate-friendly technologies. Investment conditionalities cannot offset the impact of subdued price expectations. They do not contribute to a reduction of the financing costs of decarbonization investments. Instead, in the worst-case scenario, they may encourage companies in sectors prone to carbon leakage to invest prematurely in decarbonization solutions that are currently still expensive, to continue benefiting from free supply of allowances. This undermines the key advantage of emissions trading: the ability to achieve a set emissions target at minimal cost.

From a global perspective, investment conditionality would also undermine the effectiveness of existing safeguards against carbon leakage. Emitters that do not have access to feasible mitigation options would have to purchase their emission allowances on the market. This would primarily impair the competitiveness of EU emitters on export markets, an area for which the current Carbon Border Adjustment Mechanism (CBAM) still offers no protection.

Interference with price formation, such as through a price cap, would also increase market uncertainty in the long term rather than reducing it. Market participants would conclude that adjustments to the market design are to be expected in similar political and economic crisis situations in the future. This increases the regulatory risk factor, which, given the long-term nature of decarbonization investments, is likely to have an impact on their financing costs. Furthermore, the complexity of the interactions between the ETS1 price and energy prices makes it difficult to predict the direct effects of a carbon price cap on investment returns (cepInput 6/2026).

The intense competitive pressure on Europe’s energy-intensive industries undoubtedly calls for a decisive policy response. However, rather than jeopardizing the effectiveness of the Emissions Trading Scheme (ETS), which remains Europe’s most efficient tool for climate protection, the EU should focus on improving the framework conditions for decarbonization. This primarily concerns high energy costs, bottlenecks in infrastructure development and the lack of lead markets for green technologies. The EU action plan on electrification, published in parallel, sets out some priorities in this regard. Furthermore, the ETS review should be used to formally enshrine in the Emissions Trading Directive the postponement of emissions trading for road transport and buildings (EU-ETS2), which had already been decided on an ad hoc basis (cepStudy 5/2026).