Brussels is preparing a redesign of the European Union’s carbon market as officials reconsider how to shield industry from the risk that production moves abroad to avoid higher climate-related costs.
The European Commission is reviewing options to prevent “carbon leakage” as it aligns the EU Emissions Trading System (ETS) with discussions on the EU’s 2040 climate target framework. The ETS, launched in 2005, is the bloc’s central carbon-pricing tool and is currently calibrated to deliver the EU’s 2030 goals. Commission officials argue that a more ambitious 2040 trajectory will require a fresh look at how the market works, including the way heavy industry is protected while being required to cut emissions.
At the centre of the review is whether to extend or adapt the practice of allocating some emission permits for free to sectors exposed to international competition. Under the ETS, companies in covered sectors must surrender allowances for the emissions they produce. Where firms face overseas competitors that do not pay comparable carbon costs, the EU has long used free allocation as a buffer to reduce the incentive to relocate production.
The Commission has said no final choice has been made and that “all options” are being examined. Kurt Vandenberghe, Director-General of the Commission’s climate department, told that the task is to ensure industrial investment and competitiveness can be maintained while the policy framework tightens in line with longer-term targets.
The policy question has become more complex because the EU is also introducing the Carbon Border Adjustment Mechanism (CBAM), designed to address carbon leakage by applying a carbon price to certain imported goods. CBAM’s gradual rollout is intended to reduce the incentive for EU producers to shift output to jurisdictions with weaker climate constraints. However, CBAM also triggers a rebalancing inside the ETS, because the EU’s earlier reforms linked the phase-out of free allowances in some sectors to the border measure’s introduction.
The Commission’s own guidance on carbon leakage indicates that sectors facing high risk can receive up to 100 per cent of their benchmarked free allocation, while less-exposed sectors have seen lower free allocation rates that are scheduled to decline over time. The next phase of the ETS policy debate will test whether this structure still fits an economy expected to cut emissions substantially further by 2040.
A European Parliament research briefing published in January 2026 notes that, after the EU’s adoption of a 2040 greenhouse-gas reduction target, the ETS is set to undergo a “comprehensive, mandatory assessment”. It points to a climate package in the Commission’s 2026 work programme, with a proposal to update the ETS expected by July 2026. The same briefing highlights that the Commission will assess existing anti-leakage measures, including free allocation and compensation for indirect carbon costs passed through electricity prices, and could consider updating the carbon leakage list and benchmarks.
Pressure to revisit the system has been sharpened by political disputes over energy costs and carbon prices. In early February, Czech Prime Minister Andrej Babiš urged EU leaders to overhaul the ETS, including proposals to cap allowance prices and delay the planned second ETS covering buildings and road transport fuels. He argued that higher carbon costs risk burdening industry and pushing production outside Europe, though supporters of carbon pricing say strong price signals are necessary to drive investment in cleaner technologies.
The near-term debate is also influenced by the planned introduction of the separate carbon market for buildings and road transport, commonly referred to as ETS2, which is due to start in 2028 after being delayed by a year. On 5 February, Reuters reported that the European Investment Bank would fast-track €3 billion to help governments support lower-income households ahead of ETS2’s launch, with the funding intended to kick-start consumer investments such as insulation, heat pumps and electric vehicles. The move reflects official concern that carbon pricing in consumer-facing sectors may generate political backlash unless accompanied by compensatory measures and viable alternatives.
State-aid rules are another part of the industrial protection picture. In December 2025, the Commission announced amendments to ETS State Aid Guidelines that allow member states to compensate sectors at genuine risk of carbon leakage for part of higher electricity costs linked to carbon pricing, within defined conditions. These guidelines matter because electricity-intensive producers can face costs even when direct emissions are covered by free allowances, depending on national power mixes and how utilities pass through carbon costs.
Industry groups and climate-policy organisations are seeking to shape the next round of reforms. Business federations have argued for predictability and safeguards for exposed sectors, while some non-governmental organisations have questioned whether continued free allocation weakens incentives to decarbonise if maintained beyond a transitional period. The Commission’s challenge will be to reconcile these competing pressures while maintaining the integrity of a market intended to deliver emissions cuts at least cost.
The outcome will matter for the EU’s broader climate and industrial strategy. The Commission’s 2040 target framework is intended to chart a path from the 2030 goal towards climate neutrality by 2050, with the ETS expected to remain a principal tool. A redesign that changes the balance between free allocation, border measures, state-aid compensation and tighter caps would affect investment decisions across steel, cement, chemicals, refining and other heavy industries that are central to the EU economy and to its emissions profile.
