The EU Makes Changes to Its Carbon Reduction Policy

The European Union (EU) will slow the reduction to its carbon dioxide emission caps that are part of its Emissions Trading System (ETS) over the next decade, giving industry more time to develop and implement new technologies while keeping to its goal for reaching climate neutrality by 2050 and reaching an interim goal to reduce carbon emissions by 90% by 2040 from 1990 levels. The EU is overhauling its Emissions Trading System (ETS) to give industries like steel and cement more time to adapt. To protect these businesses from high energy costs and international competition, the bloc is also planning a longer phaseout of free permits. The commission is facing pressure from governments and industry groups over carbon costs after the Middle East conflict raised energy prices, exacerbating concerns about Europe’s declining competitiveness relative to China and the United States. The proposals still need to be approved by EU countries and lawmakers – a process that could take a year.

The European Commission proposed a 3.7% annual cut to the cap from 2031 to 2035, and a 1.7% annual cut from 2036 to 2040. The pace of the emissions cap reduction has become an issue, with some governments calling for the annual rate, known as the Linear Reduction Factor, to be kept at the planned 4.4%. Some others called for it to be cut even lower, below 3%. Countries that have had factories close and companies struggle under high energy costs have pushed for the EU to lower their energy transition costs. According to Poland’s deputy climate minister, Krzysztof Bolesta, “What we don’t need is a mechanism bleeding the manufacturing sectors dry and making our continent a place of highest energy prices.”

From 2031, industries that commit to decarbonization investments can receive free emissions allocations until 2038, rather than the originally planned 2034. Companies would receive 80% of free allowances if they submit plans to invest in decarbonization, with the remainder released ​upon completion of the investment. As a guideline, the ⁠decarbonization investments should at least be equivalent to the financial value of the free carbon dioxide permits the company receives. Since 2013, ​the EU has given industries free carbon dioxide permits worth around €255 billion ($291 billion). Failure to draft a credible plan or miss milestones could result in the EU withdrawing the permit(s).

The ETS was introduced in 2005 and is the EU’s main tool for reducing greenhouse gas emissions. The ETS requires Europe’s industries and power plants to buy a permit, or allowance, for every ton of carbon dioxide they emit. Companies can buy extra permits if they emit more carbon dioxide than the free permits they receive or sell them to other companies if they have more than they need to meet the target. The EU sets a cap on total emissions that is reduced each year, making it more difficult for companies to meet the target and thereby raising the price of a permit. The extra costs companies accrue are added to the prices consumers pay for energy and other products, thereby being a de facto tax that has contributed to higher energy prices. Even before the Iran war spiked energy prices, Europe was at risk of deindustrializing in many of its key industries due to its climate policies.

Around 57% of the allowances in the EU are bought by companies at auctions. The remaining 43% of allowances are given to companies free of charge to cover some or all of their emissions. The EU generated around €43 billion ($49 billion) in revenue from the auctions in 2025.

Other EU Proposals

Alongside the EU changes to the ETS, the Commission announced a new target for electricity to make up 46% of energy consumption by 2040, doubling the current rate of 23%. The EU estimated that the new target would cut spending on imported fossil fuels by €260 billion ($297 billion) annually and would cut oil demand by 40% and natural gas demand by 70%. Since the escalation of the conflict in the Middle East, the EU has spent more than €50 billion ($57 billion) extra on fossil fuel imports. The EU’s phase-out of fossil fuels and increased electrification would require more electric vehicles, more heat pumps, and greater industrial electrification, with higher costs for consumers in member nations.

The EU is also planning to adopt guidelines to postpone penalties for energy imports that do not align with the bloc’s methane emissions regulations. The guidelines will urge member states not to apply penalties for a certain period, providing room for the market to adjust. The United States, Qatar and other gas-producing nations urged the EU to revise the rules, warning that they could jeopardize critical energy shipments, particularly LNG, that the EU needs as it reduces its imports from Russia.

Conclusion

The EU is making changes to its Emissions Trading System that will slow reductions in emissions caps and provide more free allowances to eligible companies, amid concerns about high energy prices caused by the Middle East conflict and Europe’s declining global competitiveness. Under the changes, industries that commit to decarbonization investments can receive free emissions allocations beginning in 2031 through 2038. There is considerable controversy within the bloc over the changes to the ETS, with some member states seeking no change and others calling for an even slower rate of reductions.

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