EU: What’s at stake for Europe’s carbon market blueprint?

Europe’s carbon market could get a lot weaker if some business groups get their say – Image: Federico Gambarini/dpa/picture alliance

The EU Commission has proposed to weaken Europe’s emissions trading system, a global blueprint for pricing carbon and cutting CO2. How effective is the scheme and where does it fall short?

Europe’s carbon market rarely makes headlines. But it has become one of the world’s most influential climate policies.

The bloc aims to become climate-neutral by 2050, and meeting its 2040 interim target is considered essential to achieving that goal. The EU carbon market is the bloc’s main tool for getting there.

The European Commission published a revision on Friday that would weaken the system. Under the proposal, parts of EU industry would be allowed to continue emitting climate-damaging greenhouse gases until 2038 without paying for these emissions, four years longer than planned for sectors including steel and cement manufacturing.

Under the revised rules, the EU would give 80% of the free emissions permits upfront to companies with plans to invest in decarbonization. The remaining 20% would be handed out once companies have followed through on these investment plans.

EU member states and lawmakers will negotiate the final revision over the next year.

Industrial frontrunners, including parts of Europe’s steel sector that have already invested in cleaner production, are hoping for a stronger system. But what exactly is emissions trading, and how well does it work?

The ETS put major pressure on the coal industry to accelerate its phase out – Image: DHA

What is an emissions trading system?

An emissions trading system (ETS) puts a price on pollution. Companies under the scheme must hold permits for the greenhouse gases they emit.

The European system covers aviation, oil refineries, coal-fired power stations, steelworks, cement, glass and paper production, as well as parts of the chemicals industry and shipping. Together, these sectors account for up to 40% of EU emissions, with roughly 10,000 industrial facilities, factories and power plants covered.

The idea is simple: the more a company pollutes, the more it should pay. The European Union sets an overall emissions cap and issues a limited number of allowances. Each permits the release of a specific quantity of greenhouse gases. These allowances can be traded on the carbon market.

This creates a carbon price that is designed to encourage companies to cut their emissions as quickly as possible. Revenues generated by the European system are intended to help finance the transition towards a greener economy. To keep the climate targets within reach, the emissions cap is reduced every year. Under the current rules, it falls annually by 4.3%.

EU: Where does the system work and where does it fall short?

According to the European Environment Agency, the EU’s environmental authority, the strongest results have come in the energy sector. Emissions from all stationary industrial sites covered by the system fell by 51% between 2005 and 2024.

The energy-intensive steel industry now emits around 20% less than before the scheme began.

Aviation tells a different story. According to the non-governmental organization Carbon Market Watch, emissions there continue to rise because the ETS captures only a small share of the sector’s full climate impact.

One of the system’s most powerful levers is also one of its central weaknesses: the free allocation of emissions allowances.

They were introduced as a temporary measure to protect industry during the transition. Yet two decades after the ETS system was launched, they remain widespread. According to Carbon Market Watch, around 90% of industrial emissions are still covered by free allowances. This means that industries pay the full carbon price for only a small portion of their CO2 emissions.

The current plan is to phase out these free permits gradually, but industry groups are pushing back.

“In essence, it’s big oil and petrochemicals who are lobbying heavily against it. And they are joined by some of the big manufacturing sectors that are mainly coal-based,” said Wijnand Stoefs, EU policy lead at Carbon Market Watch.

Stoefs says some companies receive more allowances than they need and sell the rest, essentially turning a profit.

Free certificates are among the most disputed details in emission trading – Image: Nicolas Economou/NurPhoto/picture alliance

EU carbon market: global blueprint with flaws?

According to the World Bank, more than 35 emissions trading systems are now operating worldwide.

Stoefs says one reason is that the European Union was an early mover and that its system became a blueprint for other countries.

Another is the EU’s Carbon Border Adjustment Mechanism (CBAM), which applies carbon costs to certain imports. The aim is to prevent imported products from gaining an unfair advantage over goods produced in Europe under stricter climate rules.

“The start of the CBAM has led to a massive uptake in Emission Trading Systems: Indonesia, Philippines, India, Turkey — they all already have one or are working to have one very, very fast,” Stoefs said.

He sees this as part of the “Brussels effect”: the ability of EU regulations to influence rules far beyond Europe’s borders.

“We put a price on carbon. Other countries are following and that is what we need. If everybody has a price on carbon, there is no competitive disadvantage. But we actually stand a chance to solve climate change,” he added.

But other countries may also copy some of Europe’s mistakes. Stoefs points to Turkey and South Korea as examples. Like in the early years of the European system, companies there can, or could, compensate part of their emissions through projects abroad.

Offsetting allows companies to keep emitting while financing projects elsewhere, such as tree-planting schemes. Environmental groups argue the approach is often intransparent and does not always deliver genuine emission cuts.

A World Bank analysis offers another cautionary example. It found no statistically significant effect of New Zealand’s emissions trading system on carbon dioxide emissions. One key reason was that agriculture, which accounts for almost half of New Zealand’s national emissions, was largely excluded from the system.

New Zealand is home to over 23 million sheep — their emissions are not covered in the national ETS – Image: Wu Jiaxiang/Xinhua/picture alliance

The battle in Brussels

The next chapter of Europe’s carbon market is now being fought over in Brussels. In a recent letter, Sweden’s Minister for EU Affairs, Jessica Rosencrantz, argued that: “Maintaining a sufficiently ambitious linear reduction factor remains the single most critical element for preserving investment incentives for industrial transition.”

She also called for emissions from waste incineration to be brought under carbon pricing.

Some business groups want the opposite, pressing for key elements to be delayed or weakened. Their demands include slowing the phase-out of free allowances and softening the European Union’s climate strategy for 2040.

Lobby group BusinessEurope argues that inflation, geopolitical conflicts, restrictions on global trade, high defence expenditure and a weak European economy are already placing industry under pressure. A further rise in the carbon price, it says, would add another significant burden on sectors already under strain from inflation and geopolitical conflicts.

Environmental policy spokesperson for the largest political group in the European Parliament, the conservative EVP, argues to push the end of free allowance allocations beyond 2039. But companies should only receive them under certain conditions.

“It is no longer acceptable for companies to use their free allowances to invest outside of Europe. The most sensible approach would be to link them to investments at the respective location. In this way, we secure jobs and simultaneously strengthen Europe as an industrial hub”, the spokesperson said.

The political fight has already had consequences. A second European emissions trading system covering fuels used in buildings and road transport was originally due to start in 2027. Following political pressure, it was postponed until 2028.

The German Environment Agency (UBA) is warning against further delays or dilution. It argues that limiting free allowances and maintaining a strong carbon market are essential if the EU is to meet its climate goals.

DW.com/NAN 18-07-26

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