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The European Commission plans to extend free emissions allowances for vulnerable industries, dedicate more carbon market revenues to decarbonization, and expand the ETS as part of its strategy to achieve climate neutrality by 2050.
The European Commission has unveiled a long-awaited reform of the European Union’s Emissions Trading System (ETS), seeking to strike a delicate balance between ambitious climate objectives and the need to preserve the competitiveness of European industry. Presented in Brussels on July 17, the proposal maintains the core principles of the carbon market while introducing a series of adjustments designed to encourage investment in decarbonization, reduce the risk of industrial relocation, and align the ETS with the EU’s increasingly ambitious climate targets.
The reform comes at a critical moment for the European Union, which has committed to reducing greenhouse gas emissions by 90 percent by 2040 compared with 1990 levels, ultimately achieving climate neutrality by 2050. According to European Climate Commissioner Wopke Hoekstra, the goal is to transform the ETS into an investment instrument capable of supporting climate action while strengthening Europe’s industrial competitiveness and energy independence.
Established twenty years ago, the ETS is the cornerstone of the European Union’s climate policy. It operates on the “polluter pays” principle by requiring the most carbon-intensive industries to purchase emission allowances. Companies that emit less than their allocated limit can sell unused permits, while those exceeding their quotas must acquire additional allowances. This market-based mechanism creates a financial incentive for businesses to reduce emissions and invest in cleaner technologies.
The Commission argues that the system has played a significant role in lowering emissions across Europe. However, some energy-intensive industries contend that they have already implemented all economically viable efficiency improvements available under current technologies. As a result, they increasingly view the ETS as a financial burden rather than an environmental incentive, particularly given the volatility of carbon allowance prices.
Business organizations representing major European economies, including Germany’s BDI, France’s Medef, and Italy’s Confindustria, recently called for substantial changes to the carbon market. They warned that excessive regulatory costs could undermine the competitiveness of European manufacturers and encourage companies to relocate production outside the European Union, where environmental regulations are often less stringent.
The Commission’s proposal attempts to address these concerns by extending free emissions allowances beyond 2030 for sectors considered at risk of carbon leakage. Rather than eliminating these allowances according to the previously planned timetable, the reduction will proceed more gradually between 2031 and 2035. During the following period, from 2036 to 2040, companies will also be permitted to count qualifying decarbonization projects implemented in third countries toward up to 2 percent of their compliance obligations.
A central element of the reform concerns how revenues generated by the ETS are spent. Since its launch, the carbon market has generated approximately €260 billion through the auctioning of emission allowances. While much of this income has traditionally been absorbed into national budgets, the Commission now proposes that at least half of all ETS revenues be legally dedicated to financing decarbonization projects.
The proposal also introduces stricter conditions for companies receiving free allowances. Eighty percent of these certificates would be granted only after businesses publish credible annual decarbonization plans outlining concrete investments and measurable emission reduction strategies. The remaining 20 percent would become available only after companies demonstrate that these plans have actually been implemented. The objective is to ensure that free allowances encourage genuine industrial transformation rather than simply reducing operating costs.
Beyond manufacturing, the Commission intends to gradually expand the ETS to additional sectors. Waste management is expected to be incorporated into the system over time, although several safeguards are included to address concerns raised by the industry. Companies operating waste collection and treatment services have argued that many aspects of their emissions depend on decisions made by public authorities and local governments rather than on factors directly under their control.
The aviation and maritime sectors would also face broader coverage under the revised ETS. The proposal extends the system to include private aviation and commercial flights covering routes of up to 5,000 kilometers from central Europe. In maritime transport, certain ports located in neighboring non-EU countries would also become subject to the carbon market, reducing opportunities for operators to avoid environmental obligations by rerouting services outside the Union.
Commissioner Hoekstra emphasized that Europe should reject the notion that economic growth and climate protection are mutually exclusive. Instead, he argued that environmental sustainability, industrial competitiveness, and energy security can reinforce one another when supported by well-designed policies and targeted investments.
Alongside the ETS reform, the Commission has proposed a broader energy objective aimed at accelerating electrification across the European economy. Electricity currently accounts for only 23 percent of final energy consumption, a figure that has remained largely unchanged for the past decade. Brussels now proposes an indicative target of raising electrification to 46 percent by 2040, reflecting the increasing importance of clean electricity in sectors such as transport, heating, and industrial production.
To support this transition, the Commission also outlined ambitions to maintain affordable electricity prices. By 2030, electricity costs should not exceed two and a half times the price of natural gas for households and no more than twice the gas price for industry. Achieving this objective, however, may prove politically challenging, as tax-related energy measures generally require unanimous approval from all EU member states.
If adopted, the reform would represent one of the most significant updates to the ETS since its creation, reinforcing its role not only as a mechanism for reducing emissions but also as a financial engine for Europe’s green industrial transformation. The proposal reflects the European Union’s effort to ensure that the path toward climate neutrality remains compatible with economic resilience, technological innovation, and global competitiveness.
Alessandro Fiorentino