Webinar on-demand: EU ETS review - Breaking down the headlines

The ETS directive review centres on a fundamental tension between the progressive left, seeking stronger climate ambition, and centre-right/pragmatist camps prioritising industrial competitiveness. Historical precedent suggests Parliament and Council will significantly reshape the Commission's proposal. The 2015-2017 ETS reform saw the MSR intake rate move from 12% (proposed) to 24% (final), illustrating how substantially initial proposals can change. Expect similar material amendments this time, with most expected changes viewed as bearish relative to the current proposal.

The Commission proposes a two-tier structure: 3.7% annually from 2031-2035, then 1.7% from 2036 onwards. This 2 percentage-point softening achieves 90% (not 95%) emissions reduction by 2040. The front-end is steeper than Energy Aspects had modelled, whilst the back-end softening creates space for international carbon offsets. Parliament is expected to push for less steep front-end and more ambitious back-end reduction; Council may argue the back-end is too aggressive. The final outcome will likely split the difference.

Market participants expected 400 Mt of IDB allowances to flood the market between 2028 and 2030. The Commission proposal fundamentally changes this: supply will backload to 2032-2033 and beyond. The mechanism is a performance bond requiring project sponsors to deposit funds upfront; failure to start construction within 30 months forfeits the bond and subsidy. This creates extreme time pressure. Even with optimistic assumptions, meaningful supply realistically cannot appear before 2032-2033. The IDB will likely survive in similar form, as politicians prioritise appearing to act on industrial decarbonisation over refining implementation details.

From 2031, free allocation will be tied to decarbonisation progress. Installations must submit decarbonisation plans to receive 80% of their allocation during 2031-2035, with the final 20% withheld until proof of compliance. Exceptions apply: the top 10% least emissions-intensive installations and fully decarbonised installations receive 100%. This mechanism will face significant political pushback, particularly from the European Conservatives and Patriots for Europe, which view it as an impediment to competitiveness. Free allocation remains a central battleground in the reform process.

International offsets are permitted but not for direct installation compliance. Instead, the Commission will use auction revenues to purchase international carbon removal credits to bridge the 2 percentage-point LRF gap. The left-leaning parties (Greens, EFA) oppose international offsets entirely, arguing they weaken the ETS, whilst pragmatist countries view them as cost-effective. A key risk: the supply of credible international carbon removal credits is limited and expensive—well above current EUA prices.

The Commission proposes 250 million tons of allowances to be cancelled in exchange for carbon removal credits (direct air capture, biochar, enhanced weathering). Carbon removal costs significantly exceed EUA prices through 2030-2035. Only €10 million of additional subsidy allocation is proposed—potentially supporting 10 Mt of removal against a 250 Mt reserve. Front-end deployment will be minimal; the reserve signals intent and prevents future market distortion from a glut of cheap credits.

The original proposal (all departing flights from EU airports) was always politically infeasible. The Commission has scaled it back to departing flights within 5,000 kilometres of the EU, excluding North American, most Asia-Pacific, and most Middle East long-haul routes. This narrower scope is more politically palatable and increases passage likelihood, though it remains contentious. Pressure exists from both sides: those arguing for full inclusion and those opposing any expansion.

Municipal waste was originally slated for 2028 but faced political resistance due to publicly owned assets. The Commission now proposes 2031 entry, phased over time. Initial estimates suggested 80-90 Mt addition; the proposal is smaller: 55-60 Mt. The later start date means no impact on 2026-2030 balances. This illustrates how the legislative process reshapes the Commission's vision: Member States with large public-sector waste operations have leverage to negotiate delays and narrower definitions.

The most significant change is recalculation of TNAC (Total Number of Allowances in Circulation) to account for aviation. If this methodology had applied to 2025, the MSR would have withdrawn approximately 200 Mt fewer allowances—a massive supply shock avoided through recalibration alone. The practical implication: the MSR will begin returning allowances to the market faster than previously modelled, starting around 2028-2029. This explains why Energy Aspects has revised its 2031-2035 EUA price forecast down by approximately €12/tonne.

Energy Aspects forecasts the EU average EUA price at approximately €82/tonne for 2026, with modest upside expected towards year-end contingent on limited bearish surprises in the legislative process. For 2031-2035, the forecast has been revised down by approximately €12/tonne from the prior base case, primarily due to TNAC recalculation and faster MSR supply recovery. This Commission proposal is the least bearish version that will be seen. Parliament and Council are likely to push for amendments that tighten the market—stronger front-end LRF, faster free allocation phase-out, or stricter aviation scope. If those changes materialise, the 2031-2035 price could fall further.

A pause or freeze to ETS-1 has no realistic support—only pragmatist nations propose it. ETS-1 will proceed as proposed. ETS-2 (buildings and transport directive) is different. It was not in the Commission proposal, but several Member States and Parliament members have floated delaying implementation from 2025 to 2030 or beyond. This has material support, particularly from competitiveness-focused nations. It is one of the easiest bargaining chips to trade during trilogues. An LRF adjustment in the 2029-2030 window has lost momentum; even proponents are cooling on the idea.