EU Commission Reforms ETS Carbon Market Amid Industry Pressure

Commission proposes changes to ETS buffer system

The European Commission has proposed changes to how the EU Emissions Trading System manages its reserve of carbon allowances. The proposal, announced on 1 April 2026, would stop the automatic cancellation of surplus allowances held in the Market Stability Reserve. Instead, these allowances would remain available for release during periods of sharp price increases.

This marks the first in a planned series of reforms to the ETS. The move responds to pressure from several member states concerned about energy price volatility, particularly following electricity cost increases linked to geopolitical tensions including the war in Iran. Countries including Italy, Slovakia, and the Czech Republic have called for interventions to reduce the impact of carbon pricing on industrial costs.

The Commission must balance competing demands. On one hand, maintaining the ETS as an effective tool for reducing emissions. On the other, addressing legitimate concerns about price volatility affecting businesses and households. The proposed change attempts to thread this needle by keeping surplus allowances as a buffer rather than removing them permanently from circulation.

Draft conclusions from the European Council meeting on 19 March 2026 called for measures to stabilize carbon prices while continuing to support decarbonization. The Commission’s proposal requires approval from both the European Parliament and Council through the ordinary legislative procedure. Meanwhile, a more comprehensive review of the ETS is scheduled for July 2026, which will examine broader structural questions about the scheme’s operation.

How the EU emissions trading scheme operates

The EU Emissions Trading System started in 2005 as a cap-and-trade mechanism covering emissions from power plants and energy-intensive industries. It has since expanded to include aviation and, from 2024, maritime transport. A separate scheme called ETS2 will cover road transport and buildings from 2028 onwards.

Under the system, authorities set a declining cap on total greenhouse gas emissions from covered sectors. Companies must hold allowances equivalent to their emissions, with each allowance representing one tonne of CO₂ equivalent. Businesses can trade allowances, creating a carbon price that makes cleaner operations more competitive. The cap reduces over time, forcing overall emissions down across participating sectors.

By 2024, emissions from covered sectors had fallen 50% compared to 2005 levels. This represents one of the more substantial emissions reductions achieved by any carbon pricing system globally. Since 2013, the scheme has generated over £150 billion in revenues, predominantly invested in renewable energy projects and energy efficiency improvements.

Recent changes under the ‘Fit for 55’ legislative package have tightened the emissions cap significantly. The revised target requires a 62% reduction in covered sector emissions by 2030 compared to 2005. Free allocation of allowances to aviation will phase out from 2026. The Carbon Border Adjustment Mechanism, which took effect on 1 January 2026, applies carbon costs to certain imports to prevent businesses relocating outside the EU to avoid carbon pricing.

The Market Stability Reserve and proposed modifications

The Market Stability Reserve acts as a buffer mechanism within the ETS. When allowances in circulation exceed 400 million, the system removes a portion from auctions and places them in the reserve. Conversely, during periods of scarcity, allowances can be released back to the market. This mechanism aims to prevent both excessive price spikes and collapses that could undermine the scheme’s effectiveness.

Current rules automatically invalidate allowances when the reserve exceeds 400 million. By the end of 2024, this process had permanently cancelled 3.2 billion allowances. Consequently, these allowances can never re-enter circulation, regardless of future market conditions.

The proposed reform would end this automatic invalidation. Surplus allowances would remain in the reserve as a permanent buffer. During periods of sharp price increases, authorities could release these allowances to moderate costs. This change responds directly to recent volatility, particularly price spikes linked to gas supply disruptions and geopolitical events.

Several member states have pressed for this type of intervention. Rising electricity prices have created political pressure to demonstrate responsiveness to cost concerns affecting both industry and households. However, the proposal must navigate opposition from those who argue that weakening the supply constraint could undermine the ETS’s environmental effectiveness.

Stakeholder consultations conducted in 2025 showed continued broad support for the ETS. Most respondents viewed the scheme as delivering value at EU level that individual member state policies could not achieve. Nevertheless, specific concerns about price volatility and industrial competitiveness featured prominently in feedback from business groups and some national governments.

Price volatility and the geopolitical dimension

Carbon prices within the ETS respond to multiple factors beyond simple supply and demand for allowances. Energy prices play a significant role because they affect the relative cost of different fuels. When gas prices rise sharply, coal becomes more economically attractive despite higher carbon intensity. This increases demand for allowances, pushing up carbon prices.

The war in Iran has contributed to gas price volatility, creating knock-on effects in electricity markets. For industries with high energy consumption, these combined pressures create significant cost uncertainty. Some sectors argue this volatility makes long-term investment planning difficult, particularly for capital-intensive decarbonization projects.

Member states have responded differently to these pressures. Some continue to emphasize the importance of maintaining a strong carbon price signal to drive investment in clean technology. Others prioritize immediate cost relief for industry and consumers. This divergence reflects broader debates about the pace of transition and the distribution of costs.

The Commission’s proposal attempts to address short-term volatility without abandoning the long-term emissions trajectory. By keeping cancelled allowances available for potential release, the system gains flexibility to respond to unexpected shocks. However, this flexibility comes with risks. If allowances are released too readily, the scarcity signal that drives decarbonization investment could weaken.

International carbon market developments add another dimension. Switzerland’s ETS has linked with the EU system. The UK operates its own scheme following Brexit. Discussions about potential linkages with other jurisdictions continue. The July 2026 review will examine these international dimensions alongside domestic market functioning.

Key details and timeline for UK businesses

• The EU ETS achieved a 50% reduction in covered sector emissions by 2024 compared to 2005, demonstrating the effectiveness of carbon pricing in driving decarbonization across multiple industries.
• Since 2013, the scheme has generated over £150 billion in auction revenues, with funds primarily directed toward renewable energy deployment and energy efficiency programmes across member states.
• The proposed Market Stability Reserve reform would retain 3.2 billion allowances that have already been invalidated, making them available for release during future price spikes rather than permanently removing them from circulation.
• The Carbon Border Adjustment Mechanism became operational on 1 January 2026, applying carbon costs to imports of cement, steel, aluminium, fertilizers, electricity, and hydrogen to maintain competitive parity.
• A comprehensive ETS review scheduled for July 2026 will examine carbon removal accounting, potential scope expansions, measures beyond CBAM to address carbon leakage, and further Market Stability Reserve adjustments.
• The revised emissions reduction target requires covered sectors to cut emissions by 62% by 2030 compared to 2005 levels, with a longer-term goal of 90% reduction by 2040 compared to 1990.
• ETS2, covering road transport and building emissions, will launch in 2028 with revenues supporting a Social Climate Fund worth £75 billion between 2026 and 2032.

Implications for UK companies trading with the EU

UK businesses exporting to the EU need to understand how these ETS changes affect their competitive position. The Carbon Border Adjustment Mechanism now applies carbon costs to certain goods entering the EU. Products from countries without equivalent carbon pricing face additional charges. This affects UK exporters in covered sectors unless future UK-EU agreements provide exemptions.

Manufacturing businesses with EU operations or subsidiaries must monitor carbon allowance costs. Price volatility creates budget uncertainty, particularly for sectors with thin margins. Companies making investment decisions about decarbonization technology face a trade-off. Higher carbon prices improve the business case for clean alternatives. However, volatility makes payback periods harder to predict with confidence.

Supply chain considerations extend beyond direct operations. Many UK businesses source components or materials from EU suppliers. Carbon costs embedded in these supplies will likely increase as the ETS cap tightens. Consequently, procurement teams need visibility of suppliers’ carbon exposure and their strategies for managing allowance costs.

Some UK businesses may benefit from tightening EU standards. Companies that have already invested in low-carbon production gain a competitive advantage as carbon prices rise. Those developing clean technologies or services find growing demand in EU markets. Early movers in decarbonization can position themselves as preferred suppliers to businesses facing increasing carbon costs.

The divergence between UK and EU carbon pricing creates complexity. The UK ETS operates independently with different rules and price levels. Businesses with operations in both jurisdictions must navigate two separate compliance requirements. This administrative burden adds costs, particularly for smaller businesses without dedicated sustainability teams.

Tender requirements increasingly reference carbon performance. Public procurement in EU member states often includes environmental criteria. Similarly, UK public sector suppliers must demonstrate carbon reduction credentials to meet PPN 06/21 requirements. Companies without robust carbon accounting may find themselves excluded from opportunities.

Understanding Scope 3 and supply chain emissions

The July 2026 review will examine how the ETS accounts for emissions beyond direct operations. Scope 3 emissions, those occurring in the supply chain and from product use, represent the majority of total emissions for many businesses. Currently, the ETS focuses primarily on direct emissions from covered installations. However, pressure is building to address supply chain emissions more comprehensively.

For UK businesses, this potential expansion matters regardless of direct ETS obligations. EU customers and partners increasingly request supply chain emissions data. Large corporations facing stakeholder pressure on Scope 3 emissions scrutinize their suppliers’ carbon performance. Therefore, businesses without credible emissions reporting may lose access to valuable contracts.

Carbon removal technologies also feature in the upcoming review. Methods including direct air capture, bioenergy with carbon capture and storage, and nature-based solutions are gaining attention. How the ETS accounts for carbon removals will influence investment in these technologies. Consequently, businesses developing or using removal solutions need clarity on future regulatory treatment.

The distinction between permanent and non-permanent carbon storage creates technical complexity. Trees sequester carbon but can release it through fire or disease. Geological storage offers greater permanence but at higher cost. The ETS review must determine how to value different types of carbon removal, balancing environmental integrity with practical implementation.

UK businesses involved in forestry, land management, or carbon removal technology should monitor these developments closely. Future mechanisms for crediting removals could create new revenue streams. Alternatively, weak accounting standards could undermine the credibility and value of removal projects. Nature-based carbon projects require robust verification to ensure claimed benefits are real and additional.

Carbon leakage and international competitiveness

Carbon leakage occurs when businesses relocate production to jurisdictions with weaker climate policies to avoid carbon costs. This undermines environmental goals because global emissions remain unchanged or increase. Simultaneously, it damages the industrial base in regions with stronger climate policies. The ETS has used free allocation and now CBAM to address this risk.

The July review will examine whether current anti-leakage measures remain adequate. Free allocation phases out in several sectors, with CBAM intended as a replacement. However, CBAM currently covers only a limited range of products. Sectors not covered by CBAM but facing international competition may require additional protection or face disadvantage.

For UK manufacturers, this creates both risks and opportunities. Products competing with EU goods may benefit if EU producers face higher carbon costs without adequate protection. Conversely, UK exports to the EU face CBAM charges unless exempted. The lack of a UK-EU agreement on carbon pricing means businesses face the full CBAM levy.

Trade negotiations between the UK and EU could address this issue. An agreement recognizing UK carbon pricing as equivalent might exempt UK exports from CBAM. However, this would require demonstrating that UK climate policies achieve comparable environmental outcomes. Political and technical negotiations on such arrangements remain at an early stage.

Global competitiveness concerns extend beyond manufacturing. Service businesses with high energy consumption face similar pressures. Data centers, for instance, consume substantial electricity. As carbon costs increase, the location of energy-intensive services becomes more sensitive to electricity prices and their embedded carbon costs.

Preparing for tightening carbon constraints

Businesses should treat the current ETS reform as a signal of direction rather than a final destination. The 90% emissions reduction target by 2040 implies far tighter constraints ahead. Carbon prices will likely rise substantially as the cap contracts. Therefore, investment decisions made now should anticipate this trajectory rather than optimizing for current prices.

Energy efficiency improvements offer immediate returns that strengthen as carbon prices increase. Many efficiency measures have short payback periods even at current energy costs. Moreover, they reduce exposure to future price increases and carbon costs. Businesses with comprehensive energy management programs are better positioned to adapt as constraints tighten.

Fuel switching represents another key strategy. Moving from coal to gas, or from gas to electricity from renewable sources, reduces both energy costs and carbon exposure. However, these decisions require careful analysis of total costs, including infrastructure investments and long-term fuel price expectations. Sustainable procurement of energy and materials requires understanding the full carbon intensity of supply options.

Carbon accounting capabilities matter increasingly. Businesses need accurate data on their emissions to identify reduction opportunities, meet compliance obligations, and respond to customer requirements. Many companies discover that measurement systems are inadequate when they first attempt comprehensive carbon accounting. Building this capability takes time, making early action important.

Employee engagement in carbon reduction often delivers results beyond formal programs. Workers familiar with operations frequently identify efficiency improvements that management overlooks. Creating channels for suggestions and recognizing contributions builds momentum. Training programs help staff understand carbon issues and their role in addressing them.

What the July 2026 review may bring

The comprehensive review scheduled for July will address questions the current MSR reform leaves unanswered. Potential changes include further adjustments to allowance supply mechanisms, expanded sectoral coverage, and new approaches to carbon removals. The outcome will shape the ETS trajectory for the rest of the decade and beyond.

Several member states have submitted detailed proposals for consideration. These range from technical adjustments to fundamental structural changes. Reconciling different national priorities will require negotiation and compromise. The final proposal must maintain majority support in both the Parliament and Council to become law.

Environmental organizations are pressing for stronger measures to accelerate emissions reductions. Industry groups emphasize competitiveness concerns and the need for predictability. Member state governments balance domestic political pressures with their negotiating positions at EU level. This complex interplay of interests makes the review’s outcome difficult to predict.

UK businesses should monitor the review process despite Brexit. Changes to the ETS affect UK companies through trade relationships, supply chains, and competitive dynamics. Major policy shifts in the EU typically influence UK policy debates and can shape future domestic regulations. Therefore, staying informed about EU developments remains commercially relevant for UK firms.

The review also offers a window into broader European climate policy thinking. How the EU approaches questions of carbon removal, industrial support, and international cooperation reveals priorities that may appear in other policy areas. Consequently, the July proposals will merit attention beyond their immediate technical details.

Where to find additional guidance

The European Commission’s climate action pages provide comprehensive information about the ETS, including detailed technical documentation, policy proposals, and stakeholder consultation materials.

The Department for Energy Security and Net Zero publishes guidance on UK climate policy, carbon pricing, and international climate negotiations affecting British businesses.

For businesses needing support with carbon reporting and compliance requirements, the SBS compliance advisory service offers practical assistance tailored to SME needs and resources.

The Carbon Trust provides technical resources on carbon measurement, reduction strategies, and emerging carbon management technologies.

Trade associations in specific sectors often publish sector-specific guidance on managing carbon costs and meeting environmental requirements relevant to their industries.