The strategy that puts Germany on track in reaching its climate goals
Several European countries are working on additional programmes next to The European Emissions...
The European Emissions Trading System (ETS) is widely regarded as one of the most successful environmental policy instruments the EU has produced. Since its launch in 2005, it has generated more than 270 billion EUR in revenue, reinvested in innovation, industrial decarbonization, and the modernization of Europe's energy system. That success has come at a cost, and with EU industry under mounting competitive pressure, the run-up to this review saw heavy lobbying from all sides.
Some stakeholders framed the review as a straightforward trade-off: ambitious climate action versus industrial competitiveness. Whether that's the right way to frame the choice is worth debating in itself.
The question that mattered most ahead of the Commission's proposal, published on 17 July, is simpler: tweaks, or a full overhaul? On our reading, the answer is clear. This is a system that has worked and delivered real results, and the Commission's proposal reflects that: adjustments to the existing mechanism, not a redesign. But a handful of the individual changes are significant enough to matter a great deal to how industry experiences the scheme over the next decade, and when.
Linear Reduction Factor (LRF)
The Linear Reduction Factor (LRF) is currently set at 4,3% for 2024–27, having been increased from 2,2% in 2021–23, and rises to 4,4% from 2028. This was agreed as part of the 2023 ETS reform to deliver the EU's 2030 climate target.
In recent months, the Commission indicated that the LRF cannot be reduced too drastically without penalizing frontrunners, but simply maintaining the current rate beyond 2030 wouldn't provide a realistic trajectory to 2040 either; it would push the ETS cap to zero around 2040, further than required under the European Climate Law.
The proposal now sets a less aggressive LRF: 3,7% from 2031 to 2035, and 1,7% from 2036 onward. This establishes a new post-2030 trajectory, aligned with the EU's 2040 climate target and the pathway to climate neutrality by 2050. The proposal therefore doesn't mean a change before 2030 but just an extra pathway post-2030.
One consequence worth naming is that a slower reduction path before 2040 doesn't just delay the pace of change; it changes the total emissions picture along the way. If the annual cap comes down more slowly, more cumulative emissions are permitted over the period, even though the 2040 endpoint itself doesn't move. The EU’s target of 90% by 2040 stays the same. The area under the curve doesn't.
Market Stability Reserve (MSR)
Ahead of the review, there were calls to significantly change the MSR. The Commission clarified some weeks ago that any modifications would remain rule- and volume-based rather than triggered by price levels. A tweak, not an overhaul.
The MSR will be made more dynamic, with its parameters adjusted to the shrinking market after 2030. The rate at which it absorbs allowances will drop from 24% to 12%, meaning more permits stay in the market for longer. From 2029, the intake and release thresholds that govern the MSR will also reduce by 4% per year.
Some critics have raised the obvious counterpoint: keeping more allowances in the market for longer increases the risk of oversupply, and an oversupplied market blunts the price signal that gives the ETS its teeth. That tension – more breathing room for industry now, potentially less pressure on the system to deliver later – runs through several of this proposal's changes, not just the MSR.
“The MSR proposal complements a separate Commission initiative* announced in April, which would stop the automatic cancellation of ETS allowances and retain permits held in the MSR above the current 400 million threshold. That proposal will now also be assessed alongside the broader ETS review.”
Free allocation
The proposed changes to free allocation can be summed up as:
A slower phase-out schedule for CBAM sectors,* extended from 2034 to 2038. Benchmark-based allocation extended beyond 2030. Continued support after 2030 is made conditional on operators developing 'Invest in EU Decarbonization Plans' and investing an amount equal to 100% of the value of their free allocation into EU decarbonization. Member states retain the option to support indirect carbon costs via the carbon leakage framework until 2038.
The upshot: free allocation remains primarily a carbon leakage protection instrument, not an investment enforcement tool or a substitute for a credible EUA price signal, which some stakeholders had advocated for.
“The devil is in the details because, according to Argus, the Commission is also expected to propose a separate legal act on sector-specific fallback benchmarks,* used to calculate free allocations when product-specific carbon-intensity benchmarks aren't available. If approved, this could result in around 6 billion EUR of additional free EUAs being allocated to industry for the remainder of ETS Phase 4, which ends in 2030.”
These changes to free allocation carry through to CBAM. For 2026 and 2027, CBAM is unaffected. From 2028: published benchmark values will need to be recalculated, and importers' certificate liabilities will ramp more slowly. The free allocation deduction stays higher for longer, meaning full-cost CBAM arrives roughly four years later than under current law.
The EU's ETS reform directly reduces CBAM costs for importers. The exact reduction depends on sector and production method.
ETS revenue flowing back to ETS sectors
Since 2023, member states have been required to direct ETS revenues toward climate and energy-related purposes, though large amounts still go to programmes not directly aimed at reducing emissions.
According to Commission data, 78% of historical ETS revenues have flowed into national budgets, with only 5% spent on industrial decarbonization. The proposal targets raising that 5% to 50%.
One mechanism for reaching this is the new Industrial Decarbonization Bank (IDB), which will provide 100 billion EUR in funding to industrial decarbonization projects and return a higher share of ETS revenues to the sectors covered by the scheme.
An Investment Booster will kick-start the Bank, rewarding early movers on decarbonization with an estimated 30 billion EUR as Phase I of the IDB.* The Innovation Fund remains the key tool for bringing low-carbon innovation to market and scaling clean-tech industries.
Member states will also face a stronger, binding requirement that locks in the original goal: 50% of national ETS auction revenues must go toward investments that decarbonize ETS sectors.
Carbon removals and international carbon credits
The Commission has proposed integrating carbon dioxide removals into the ETS, creating 'extra emission space' for hard-to-abate sectors while helping kickstart and scale the removals sector. Any integration would be limited to permanent, domestic removals certified under the EU's Carbon Removal Certification Framework (CRCF), currently direct air capture with storage (DACCS), bioenergy with carbon capture and storage (BECCS), and biochar carbon removals.
Three implementation options are on the table: a public authority purchasing and centrally managing removal credits; operators purchasing credits individually; or companies meeting part of their compliance obligation through removal credits under a one-for-one offsetting principle.
The Commission has faced criticism, including from the International Emissions Trading Association, for excluding nature-based removals from this integration. IETA has argued that a mix of engineered and nature-based solutions would help scale the removals sector while supporting the EU's broader climate objectives.
High-integrity international credits, as provided for under the European Climate Law, would also become usable from 2036, through a dedicated facility, creating additional emissions space of up to 2% while maintaining the underlying 90% target.
In practice, this points to roughly 250 million tonnes of permanent domestic removals being integrated from 2030, with the cap adjusted accordingly, and up to 260 million tonnes of international credits from 2036. A pilot phase for international credit integration is also possible as early as 2031.
The logic here is straightforward: it eases pressure on European industry by allowing some of the reduction to come from removals or purchased credits rather than requiring it all to come from cutting emissions directly. That's a deliberate design choice, and one that will only hold up if the safeguards against double-counting and low-integrity credits do too.
Emissions reductions remain the priority throughout. The amount of removals usable in the ETS will be strictly limited and accompanied by safeguards to preserve the system's environmental integrity and keep strong incentives to reduce emissions directly. Only domestic, permanent removals certified under the CRCF will be eligible, and their permanent storage will remain subject to the ETS's existing monitoring, reporting and verification rules.
ETS scope extension: aviation, maritime and waste incineration
The Commission has proposed expanding the ETS scope to cover more of international aviation, smaller maritime vessels, and municipal waste incineration.
Intra-European flights have been covered since 2012. To address what the Commission calls an “unlevel playing field for EU airlines”, the proposal applies the ETS, from 2029, to departing international flights within 5.000 km of the EU, and to all incoming and departing flights by business jets. CORSIA continues to apply in law for 2027–35, with a deduction mechanism to avoid double carbon pricing for costs already incurred under CORSIA.
For maritime, the proposal extends coverage to smaller ships by lowering the threshold from 5.000 gross tonnage (GT) to 400 GT, creating a level playing field with the larger vessels already covered. The proposal also brings more neighbouring, non-EU ports into scope, to prevent vessels rerouting through nearby ports specifically to avoid the ETS.
Municipal waste incineration is introduced gradually, phased in from 2031 to 2034: 25% of verified emissions in 2031, 50% in 2032, 75% in 2033, and 100% from 2034 onward. Derogations apply for waste co-incineration installations in outermost regions, and a national opt-out is possible until 2035 if two of three conditions are met: an equivalent national carbon tax, being on track for recycling targets, or being on track for landfill targets.
What this means for industrial buyers
For industrial energy buyers, the practical question isn't tweaks versus overhaul, it's near-term versus long-term. Most of what eases pressure on industry in this proposal doesn't arrive for years. The LRF only becomes less aggressive from 2031. Full-cost CBAM is delayed to 2028 at the earliest, and meaningful free allocation support doesn't extend until after 2030. If the changes that matter most only land in 2030 and beyond, while implementation itself doesn't begin until 2028, that's not bringing any immediate relief to industry, whatever the proposal's stated aims around competitiveness.
What is available sooner is worth tracking separately. The Investment Booster's 30 billion EUR is intended to reward early movers, not those who wait, and the continuation of indirect cost compensation, where member states already offer it, is immediate. Buyers deciding whether to act now or wait for the reform to bed in should treat those two as the near-term opportunities, and everything else as a multi-year trajectory to plan around rather than rely on for relief this year or next.
Timeline
Following publication on 17 July, the European Parliament, Council and Commission are expected to negotiate as of September 2026 and agree the proposed reforms by the first quarter of 2027, with implementation planned for 2028.
This proposal forms the basis for trilogue negotiations, where a stand-off already looks likely between countries broadly defending the system as it stands, such as the Netherlands, Sweden and Spain, and those pushing for a more fundamental overhaul or even abolition, such as Poland and Italy.
Conclusion
So, tweaks or reform? Tweaks, decisively. The core mechanism, the cap-and-trade structure, the MSR, the LRF's basic logic, stays intact. What changes is the pace and the room around the edges: a slower reduction path, a longer runway for free allocation, new mechanisms bringing removals and international credits into the system, and a wider scope.
For now, this is a proposal, not policy. It heads into trilogue negotiation, and the two camps are already visible. Expect the details, especially the post-2030 numbers, to move before this is finalized, likely by Q1 2027, with implementation from 2028.
The one thing unlikely to change: don't expect meaningful relief before then. Whatever position the trilogue lands on, most of what's being offered to industry plays out over the next decade, not the next year.
* Some of the reporting cited here sits behind a subscription paywall (Argus Media, Bloomberg). We've kept these sources linked for transparency and traceability, since we believe you should be able to see where a claim comes from, even where the full article itself isn't freely accessible.
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