The 2026 EU ETS Revision: A New Framework for Industrial Decarbonisation
Updated: Aug 22
In July 2026, the European Commission tabled a long-awaited proposal to revise the EU Emissions Trading System (EU ETS). The ETS is one of the most important pillars of the European Green Deal and aims to reduce greenhouse gas emissions. The EU ETS was established in 2003 (EU ETS Directive), has evolved into a key instrument for achieving the EU's cliamte objectives. The current system is designed to reduce net greenhouse gas (GHG) emissions by at least 55% by 2030, compared with 1990 levels, and to support the longer-term objective of achieving climate neutrality (net-zero GHG emissions) by 2050. The revision aims to update the ETS to align with the new climate target, which is the 2040 of -90%.
The ETS is based on a cap-and-trade system for emission allowances. The cap is the limit of the total amount of GHG that can be emitted by installations and operators covered under the scope of the system. Companies in key sectors such as steel, chemicals, and glass are required to obtain sufficient allowances each year to cover all their greenhouse gas emissions. While most allowances are sold at auction, some are allocated free of charge, particularly to energy-intensive industries that face international competition. This mechanism aims to reduce carbon leakage, and therefore, the carbon leakage list was implemented, where sectors considered at significant risk of production/emissions are included. Those companies receive free allowances.
What did the European Commission propose in the revision of the EU ETS?
The Linear Reduction Factor (LRF)
LRF determines how fast the allowances are reduced every year, driving up the cost of polluting as supply shrinks. The current LRF is around 4.3% per year and was designed mainly to help the EU reach its 2030 climate target. The Commission proposed a different trajectory after 2030. For 2031-2035- 3.7%, and for 2036-2040- 1.7%.
Free allocation
Free allocation would continue beyond 2030 in some form, with stronger conditions linking support to decarbonisation investment. From 2031, all free allocation is made fully conditional upon operators submitting a verified decarbonisation investment plan, with 80% of allowances released upon plan approval and the remaining 20% contingent on demonstrated emissions reductions by the end of each five-year period.
Permanent carbon removals
Currently, permanent carbon removals such as DACCS/BioCCS are not integrated as a normal compliance instrument in the ETS. The proposal incorporates domestic permanent carbon removal units into the EU ETS by increasing the overall cap by 250 million allowances. These additional allowances will be auctioned by the Commission between 2031 and 2040, with the revenue raised used exclusively to purchase BioCCS and DACCS certified under the Carbon Removals and Carbon Farming (CRCF) Regulation.
Market Stability Reserve (MSR)
MSR is the ETS’s automatic mechanism for managing the number of allowances available in the market. The revision will make MSR more dynamic, and will be adjusted for a much smaller post-2030 carbon market and to improve liquidity and price stability.
Industrial Decarbonisation Bank
The proposal includes an Industrial Decarbonisation Bank of around EUR 100 billion from 2028, as a new EU-level entity to support the scale-up and deployment of emissions reduction technologies in stationary installations. Additionally, the Innovation Fund would be expanded/strengthened and complemented by additional industrial support mechanisms.
Use of ETS revenues
ETS revenues primarily flow to the national budgets of Member States. Member States receive auction revenue and are required to use significant amounts for climate-related purposes. The proposal sets a requirement for Member States to allocate at least 50% of ETS auction revenues to defined priority areas - including clean energy and grids, low-carbon transport, industrial decarbonization, waste management, and research and innovation. Investments incompatible with climate neutrality, including fossil fuel lock-in are explicitly prohibited.
Expansion of the ETS scope
The propsal also expands the sectoral scope of the ETS to aviation, maritime transport and municipal waste incineration. For aviation, the decision to extend the ETS to flights departing Europe with a radius of over 5,000 km finally goes some way to tackling Europe’s international aviation emissions. Flights to airport hubs like Dubai will now be covered. But flights beyond that, including the US and China, are excluded. Marine transport will be extended to international shipping and to many smaller ships from 2031. The Commission also proposed to allocate millions of ETS allowances to support clean shipping and aviation fuels to reduce the cost gap to fossil fuels.
International carbon credit
International credits are essentially not used for compliance in the current EU ETS.
The proposal opens the possibility of using around 260 million high-quality international credits from 2036 onward.
Overall, the proposed revision marks an important shift in the EU ETS as the EU moves from its 2030 climate target towards the more ambitious 2040 target. While the reform would continue to tighten emissions constraints, it also places greater emphasis on supporting industrial decarbonisation through conditional free allocation, targeted ETS revenues and new financing mechanisms. The key challenge will be balancing faster emissions reductions with the competitiveness of European industry and the risk of carbon leakage. The proposal is only the beginning of the legislative process, and negotiations in the European Parliament and Council will determine how this balance is ultimately reflected in the post-2030 EU ETS.
