When the European Commission published its long-awaited overhaul of the EU Emissions Trading System on Friday, it did so with the language of balance: relief for industry while maintaining the ETS’s essential role in the climate transition, in line with EU Climate Law. The press release used the phrase “conditional free allocation” four times. It mentioned the 2040 climate target repeatedly. What it described, in practice, was a system being stretched across a decade longer than originally designed, with its core mechanism — the annual tightening of the emissions cap — dialled down at precisely the moment when the science demands it be dialled up.
The numbers are concrete. The Linear Reduction Factor, the rate at which the total cap on emissions shrinks each year, falls from its current 4.3 percent to 3.7 percent from 2031, and then to 1.7 percent from 2036. The practical consequence is that heavy industries will be permitted to emit more CO₂ over the period than the previous trajectory allowed, buying time — and doing so at a moment when the Commission is framing the trajectory as “more gradual and aligned with the EU’s domestic climate ambitions.” That framing deserves scrutiny. The EU’s 2040 target — a 90 percent net reduction in greenhouse gas emissions against 1990 levels — has not changed. The pace of getting there has. Whether a slower approach to 2031 can be compensated by a steeper one in 2036-2040 is a modelling question with a deeply uncertain answer, and the Commission’s proposal does not make that uncertainty visible.
For steel and cement manufacturers, free CO₂ permits will now run until 2038, rather than ending in 2034 when they were due to be replaced by the EU’s carbon border charge on imports. As a result, the full phase-in of the Carbon Border Adjustment Mechanism — the instrument designed to prevent carbon leakage by placing a price on the embedded emissions of imports from countries without equivalent carbon pricing — is also delayed to 2038. The CBAM was presented, when it was created, as the mechanism that would allow the phase-out of free allowances by protecting European producers from unfair competition. It is now arriving four years later, and the free allowances it was meant to replace will run in parallel with it for longer than anyone initially envisaged.
The conditions attached to the free permits are more complex than past arrangements. For each five-year period, 80 percent of the total allocation will be distributed in advance to firms with European decarbonisation investment plans, while the remaining 20 percent will be released only after verifying that those investments have been carried out. This conditionality is the reform’s most substantive innovation, and it is worth taking seriously: the Commission is, in effect, attempting to transform what was previously an unconditional subsidy to high-emitting industries into a conditional instrument that ties public support to private investment in clean technology. Whether the verification architecture can deliver on that promise is an open question. Investment plans are not investments. The gap between a company committing to a decarbonisation roadmap and a company actually building the infrastructure that roadmap describes is where, historically, industrial policy commitments have gone quiet.
A new Industrial Decarbonisation Bank, backed by a €100 billion budget, will fund emission-reduction projects in industry and channel a larger portion of ETS revenues back to the covered sectors. Industries will also be able to bid for a share of a further €70 billion worth of allowances from 2031 to support decarbonisation investments. The combined financial firepower is substantial and represents a genuine attempt to do something the ETS alone could never do: provide the capital certainty that long-cycle industrial investments in hydrogen, carbon capture, and electrification require. A steel plant that commits to switching from blast furnace to direct reduction using green hydrogen is committing to a fifteen to twenty year capital cycle. Carbon price signals, however well designed, are insufficient on their own to anchor that kind of investment decision. The Industrial Decarbonisation Bank is the Commission’s recognition that the transition requires public co-investment, not just a market mechanism.
The environmental reaction has been proportionate to the stakes. Bellona Europa and twenty-four co-signatories warned that decreasing the intake rate of surplus allowances in the Market Stability Reserve and removing the invalidation clause together pose a significant risk of persistent oversupply and weaken the investment signal needed to drive investment in low-carbon technologies. The Market Stability Reserve is the ETS’s circuit breaker — the mechanism that removes surplus allowances from circulation when the market becomes oversupplied, preventing carbon prices from collapsing to the point where they no longer influence investment decisions. Under the reform, the rate at which a market stability reserve adds or removes permits if supply fluctuates dramatically is halved to 12 percent from 24 percent today. A less responsive reserve, combined with a slower cap reduction, creates the conditions for exactly the kind of prolonged low-price environment that plagued the ETS between 2009 and 2017, when carbon prices fell so far that the system ceased to function as a meaningful incentive for decarbonisation.
The political logic behind the reform is not difficult to reconstruct. The plans respond to pressure from industries and countries, including Italy and Poland, which say the existing system undermines competitiveness. Volkswagen’s restructuring, announced just three weeks ago, provided a vivid illustration of what European manufacturing is contending with: US tariffs adding €4 billion to annual costs, market share under pressure from lower-cost competitors, and a capital expenditure cycle squeezed between falling margins and rising compliance costs. The political pressure to demonstrate that Brussels is listening to industry — and not simply imposing regulatory burdens while the competitive landscape shifts around them — is real and not irrational. A carbon market that drives European steelmakers out of business while imports from non-ETS jurisdictions arrive without equivalent pricing is not a climate policy. It is a deindustrialisation policy with green branding.
What the reform does not resolve is the tension at the heart of the ETS’s design. The system works by making carbon expensive enough that it becomes rational to invest in alternatives. A slower cap reduction and a less responsive reserve both put downward pressure on the carbon price, which is the signal that drives that investment rationality. The Commission is simultaneously trying to slow the price mechanism and compensate for that slowdown with direct public funding. Whether a €100 billion Industrial Decarbonisation Bank can substitute for the investment signal that a robust carbon price provides is the central empirical question on which the entire reform’s climate credibility rests, and the proposal does not answer it.
June 2026 was the hottest June on record across Western Europe, with an average temperature 3.05°C above the 1991-2020 baseline, according to the Copernicus Climate Change Service. The heatwave that killed more than seventeen thousand people across the continent — the same heatwave that prompted the European Parliament’s emergency debate ten days ago — was fuelled by precisely the accumulated atmospheric warming that the ETS was designed to slow. That context is not incidental to the reform. It is the frame within which the Commission’s decision to ease industrial carbon constraints must be judged.
The European Environmental Bureau, responding to the reform’s publication, noted that seven out of ten European citizens, including those voting for parties often portrayed as sceptical of EU climate policy, believe the biggest polluters and climate laggards should pay more. That finding sits uncomfortably alongside a reform that gives the biggest polluters more time and more support before they are required to pay. The Commission would argue — and it is not a negligible argument — that a politically sustainable transition is better than an economically ruinous one that produces a backlash destroying the climate architecture entirely. The counter-argument, advanced by every major environmental body that has responded to the proposal, is that the atmospheric physics of climate change does not negotiate on political timelines, and that the accumulated cost of slower action is borne not by industrial shareholders but by populations, ecosystems, and the people — disproportionately older, poorer, and less mobile — who die in heatwaves.
Both arguments are true. The ETS reform is what happens when an institution tries to hold both simultaneously, and discovers that the space between them is smaller than the distance required to satisfy either.
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