EU ETS Proposal Softens Carbon Cap Cuts as Brussels Responds to Industry Pressure
The European Commission has proposed lowering the annual rate at which the EU ETS emissions cap declines, officials said at a press conference on Friday.
The proposal for reforming the EU Emissions Trading System (ETS) comes as the EU seeks to address high energy costs and concerns over falling industrial competitiveness.
However, according to leading carbon analyst Mark Lewis, the proposal would allow installations covered by the scheme to emit carbon dioxide for nearly a decade longer than expected under the current rules.
Lower LRF
The Commission suggested lowering the rate of annual cuts to the carbon cap, known as the linear reduction factor (LRF), to 3.7% from 4.4% between 2030 and 2035. The pace of emissions reductions would then slow further, with the LRF falling to 1.7% from 2036.
Market expectations had been for the LRF to be lowered to 3.4% per year, down from 4.4% from 2028, in line with what senior EU lawmaker Peter Liese had advised in March. Liese will be the European Parliament’s lead negotiator on the upcoming EU ETS reform.
His group in the European Parliament — the center-right European People’s Party (EPP) — broadly supports the Commission’s proposal, despite the smaller reduction in the first part of the decade. “Maybe we need some fine-tuning, but the direction is good,” Liese told journalists in a briefing on Friday.
Lewis, who is also a partner at KraneShares’ Climate Finance Partners, expressed surprise at the proposal. “They’ve gone all the way back to pre-Fit-for-55 levels,” he told OPIS, referring to the EU’s 2021 climate policy package designed to cut net greenhouse gas emissions by at least 55% by 2030. The LRF was 1.74% before 2020.
According to his calculations, instead of reaching zero emissions from ETS-covered sectors by 2039, in line with the current rules, “you don’t get to zero until 2048,” giving installations nearly 10 more years to emit CO2.
Allowing International Credits in the ETS
The Commission has proposed allowing “high-quality” international credits to account for up to 2% of the EU ETS cap to give “breathing space in 2036-2040 when the emission reduction in Europe will become more challenging.”
International credits include carbon credits generated by emissions reductions or removals outside the EU under the Paris Agreement’s Article 6 framework. However, the definition of “high-quality” credits remains contested.
The Commission has previously said that if international credits are allowed into the EU ETS, purchases would be centralized, rather than allowing companies to buy the credits themselves.
Extra Free Allocation Before 2030
As previously expected, the Commission has proposed to hand out €6 billion worth of extra free allowances between 2026 and 2030 in a fast-tracked procedure to amend the free allocation benchmarks. According to Liese, some commissioners and member states came up with “a so-called quick fix, or a separate legal proposal just to change the legal base for the benchmarks immediately.”
After media reports on July 8 revealed the Commission’s plans, the benchmark December 2026 EUA fell to an OPIS-assessed €79.510/mt, down €1.155 day on day.
Free carbon allowances are handed to large emitters in several industrial sectors covered by the EU and U.K. emissions trading systems to prevent operators from being at a competitive disadvantage to imports from countries without carbon prices. By design, free allocation should be phased out completely while its mirror policy — the carbon border adjustment mechanism, or CBAM — is phased in.
Industrial Decarbonization Bank, ETS Investment Booster
In line with previous announcements, the Commission proposed establishing an Industrial Decarbonization Bank (IDB) to provide €100 billion ($114 billion) in funding to industrial decarbonization projects.
“The ETS Investment Booster will kick-start the Bank by rewarding companies that invest early in decarbonization with an estimated €30 billion as phase I of the Industrial Decarbonization Bank,” the statement read.
The scheme would allocate 400 million EUAs to companies investing early in industrial decarbonization projects. The allowances would not be handed out all at once, with media reports on Wednesday suggesting that allocations to industry could be spread over a decade.
“We want to give industry more time, but during this period, they must not sit back and do nothing; instead, they must prepare the specific investments,” Liese said. “Frontrunners in decarbonization must not be penalized.”
Under the Commission’s proposal, the 10% most efficient installations would be exempt from conditionality rules, while zero-emission installations would be allowed to remain in the ETS until 2040, rather than 2030, enabling them to finance further investments through free allowances.
In a briefing on Wednesday, Liese said he had proposed the extension to reward companies that decarbonize early, and had received positive initial feedback across all three EU institutions. “I’m optimistic that it will fly,” he said.
Market Stability Reserve
The Commission did not propose any major unexpected changes to the Market Stability Reserve (MSR). Proposed changes include introducing dynamic thresholds for the MSR, “with a fixed annual reduction of 4% per year as from 2029.” The intake rate of the reserve would also be reduced to 12% from 24% starting 2028 — a change that would allow more permits to stay in the market for longer.
The MSR is an EU mechanism that started operating in 2019 and is designed to keep the carbon market balanced by adjusting the supply of EUAs. It works by automatically withholding excess allowances from auction volumes if the total number of allowances in circulation (TNAC) exceeds a set threshold. Conversely, it releases allowances back into the market when supply becomes too tight and the TNAC falls below a lower threshold. To keep the MSR aligned with the shrinking EUA cap, these thresholds are likely to be adjusted downward.
Aviation
The Commission has proposed extending EU ETS rules to “departing international flights to destinations within 5000 km from [the geographical center of the] EU … and to all incoming and departing flights by business jets.”
Lewis called the decision “politically clever.” “It will expand the cap without without triggering massive political controversy. It’s a smart way of bringing more international flights under the coverage, but it’s not really a game changer at this stage.”
The Commission’s statement also mentioned the introduction of “a deduction mechanism for costs incurred under CORSIA (Carbon Offsetting and Reduction Scheme for International Aviation)” to avoid double carbon pricing.
Maritime
The proposal extends the ETS scope to certain categories of smaller vessels — those between 400 and 5,000 gross tons — and introduces simplification measures for shipping companies. It also supports progress at the International Maritime Organization (IMO) by avoiding double payments by shipping companies.
The proposal for reforming the EU ETS will be debated by EU member states and the European Parliament over the next 12-18 months.
Duncan Woods, senior policy officer at the European Environmental Bureau, a network of environmental citizens’ organizations, said: “At a time when the global race for clean industry is accelerating, weakening the carbon market means weakening Europe’s competitive edge.”
Historically, carbon prices were very low due to a large surplus of allowances in the market. In 2013, the average price of an EUA was just €4.45/mt, providing little incentive for installations to decarbonize.
This changed after the MSR began operating, tightening supply by removing excess allowances from auction volumes. Prices rose sharply in the following years, reaching an OPIS-assessed high of €100.34/mt on Feb. 21, 2023. After this peak, the market cooled, with EUAs trading largely within a €60–€80/mt range during 2024 and 2025, before breaking out of that range at the end of 2025.
–Reporting by Nia Simeonova, nsimeonova@opisnet.com; Editing by Rob Sheridan, rsheridan@opisnet.com