EU Carbon Market Reform: The Summer's Big Overhaul

A More Relaxed Allowance Reduction Pace

The text proposes slowing the pace at which emission allowances are cut, a rate set by the linear reduction factor (LRF). Currently at 4.3%, this rate would rise to 4.4% in 2028, then fall to 3.7% between 2031 and 2035, before dropping further to 1.7% from 2036 onwards. The result: the total exhaustion of allowances would be pushed back from 2039 to a range between 2046 and 2048.

The market stability reserve (MSR), which regulates prices by withdrawing or reinjecting allowances, would also be adjusted: the withdrawal trigger threshold would drop from 1.09 billion to 947 million allowances, with the intake rate cut from 24% to 12%. Conversely, the lower threshold would be lowered from 400 to 300 million, triggering the release of 100 million additional allowances. Both thresholds would then decrease by 4% each year starting in 2029.

Free Allocation Extended to 2038

While the phase-out of free allowances was initially planned for 2034, the Commission proposes reinstating 15% of free allocation from 2028, pushing the full phase-out back to 2038. This decision effectively slows the rollout of CBAM and gives more leeway to the sectors concerned (steel, aluminium, cement, fertilisers, hydrogen, electricity).

Between 2021 and 2025, free allocation accounted for an average of 85% of emissions from energy-intensive industries. The Commission expects this figure to average 78% for 2026-2030.

New for this reform: from 2031, 80% of free allowances will be conditional on companies publishing decarbonisation investment plans, with the remaining 20% only granted after verifying an actual drop in emissions. Companies that relocate outside the EU will have to hand their allowances back.

A €6 Billion Technical Adjustment

Also on 17 July, the Commission proposed, through a fast-tracked procedure, a revision of the calculation benchmarks (the "fallback benchmarks") used for free allocation based on heat and fuel consumption, an adjustment worth €6 billion. This revision follows the 15 June agreement among member states on 2026-2030 allocation values, which was reached on condition that the Commission revise these two key variables, seen by member states as too costly for industry. Lobby group European Metals, however, believes the proposal doesn't go far enough to meet the commitments made by the Commission.

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Financing Industrial Decarbonisation

Member states will now have to dedicate at least 50% of their revenues from allowance auctions to decarbonising ETS-covered sectors, up from an average of 5% today. A change likely to unsettle some finance ministers, wary of losing control over these funds.

To kick-start investment, the Commission also plans to launch a transitional financing instrument, the ETS investment booster, backed by 400 million allowances and announced for 2027. From 2031, it would be replaced by an Industrial Decarbonisation Bank, financed by an additional 400 million allowances, with an estimated total budget of €100 billion (including €30 billion from the booster).

International Carbon Credits and Carbon Removals: The New, Contested Levers

The reform also introduces two unprecedented mechanisms to help reach its targets.

First, international carbon credits, created under the Paris Agreement, could be used from 2036 for sectors such as steel, cement, and chemicals, up to 260 million tonnes. The Commission itself would purchase these credits to allow for a less steep reduction trajectory. The S&D and the Greens have already firmly opposed this: for Mohammed Chahim, it's "a step backwards," a form of comfort that outsources climate ambition while disadvantaging Europe's industrial frontrunners. NGO Carbon Market Watch argues the EU is offloading its climate responsibility onto "dodgy offsets." On the industry side, chemical federation Cefic welcomes the inclusion of these credits, while BusinessEurope criticises the uncertainty around how they'll be used. The Commission is due to review the state of the credits market by January 2033, with a possible revision of the emissions trajectory as a result.

Second, carbon removals (up to 250 million tonnes from 2031) would bring direct air carbon capture and storage (DACCS) and biogenic carbon capture and storage (BioCCS) into the ETS. The Commission would purchase removals certified under its CRCF framework, increasing available allowances accordingly. The Nordic Carbon Removal Association calls this a "landmark moment," one likely to create significant demand for the sector. Thierry Grauwels of industry group CCSA describes it as exactly the kind of long-term investment signal needed to build a European carbon removals industry. NGOs remain skeptical: WWF, which also challenges the certification methodology for BioCCS projects, calls the inclusion "deplorable" and warns of a risk of net emissions increases. Carbon Market Watch acknowledges the need for removal solutions but argues the ETS is the wrong tool to fund them, warning against locking in removal volumes that haven't yet materialised, or that may prove too costly.

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Homaio's Take: A Compromise, Not a Shock

The Commission sought a middle path, offering concessions to both industry (more time, more flexibility) and climate advocates (the 2040 target maintained, on paper). It's this calculated balance that explains why the carbon price hasn't really moved so far: the market reads it as a compromise rather than a shock, with no clear winner or loser.

Still, opinions diverge on the actual trajectory toward the 2040 target. The Commission itself acknowledges it isn't easy to precisely assess the ETS's contribution to that goal, estimating a reduction range of 85-87% by 2040. Consulting firm Climact, for its part, estimates the current version of the text would only deliver an 80% cut over the same period, putting the EU on track to miss its target.

What Comes Next

These announcements have divided the MEPs handling the file. Renew's negotiator Emma Wiesner calls the reform "extremely disappointing" and describes the slowdown in the reduction pace from 2031 as "catastrophic." The S&D strikes a similar note, with Mohammed Chahim calling the text "disappointing, at a time when we should be stepping up our efforts." The Greens' Michael Bloss argues the plan could add as much CO2 as Germany, Poland, and Italy emit combined in a year. The ECR, by contrast, flags competitiveness concerns and has even suggested suspending the system altogether.

Lead negotiator and EPP MEP Peter Liese defends a trajectory he considers "more realistic" than the current plan, which called for allowances to run out by 2039, while acknowledging it may still need fine-tuning: more emissions allowed in the first half of the 2030s, and fewer in the second. On financing, Liese expects MEPs to back channeling at least half of ETS revenues to affected sectors, while member states are pushing for more freedom over how they spend them.

Amendments are expected to be presented in September, with finalisation hoped for by the first quarter of 2027, in line with a recent interinstitutional agreement.