EU Plans Slower CO2 Cuts and More Free Permits for Industry

EU plans to slow carbon reductions and extend free permits

The European Commission is preparing to overhaul the EU Emissions Trading System, proposing to slow mandatory carbon cuts and expand free allowances for heavy industry. The draft revision, scheduled for publication on 17 July 2026, would extend emissions permits into the 2040s rather than eliminating them by 2039 as current rules require.

This represents a significant shift in EU climate policy. The proposed changes respond to pressure from steel, cement and chemical manufacturers facing rising costs and competitive disadvantages against global rivals. However, the plans risk weakening the carbon price signal that drives decarbonization across European industry.

For UK businesses trading with the EU or competing in similar sectors, these developments matter considerably. Changes to the EU ETS influence carbon pricing discussions globally and affect the competitive landscape for energy-intensive industries. Moreover, businesses participating in UK compliance schemes often monitor EU policy closely as both systems share common origins and similar market dynamics.

How the EU carbon market currently works

The EU Emissions Trading System covers roughly 40% of the bloc’s greenhouse gas emissions. It places a cap on total emissions from power plants, industrial facilities and aviation. Companies receive or purchase allowances, with each permit representing the right to emit one tonne of carbon dioxide.

Under existing rules, the total number of allowances decreases by 4.3% annually. This linear reduction factor creates scarcity, driving up permit prices and encouraging businesses to cut emissions. The current trajectory would eliminate available permits entirely by 2039, forcing complete decarbonization of covered sectors.

Many industrial facilities receive free allowances to prevent carbon leakage, where companies relocate production to regions with weaker climate rules. These free allocations reduce compliance costs for sectors deemed at risk of international competition. Consequently, the volume and duration of free permits directly affects business planning and investment decisions across European manufacturing.

Proposed changes to emission reduction targets

The Commission’s draft proposal would slow the linear reduction factor, extending the system’s timeline to align with the EU’s 2040 climate target. This target commits to cutting domestic emissions by 85% and overall emissions by 90% compared to 1990 levels. Therefore, the revised carbon market would maintain some level of permitted emissions into the 2040s.

Kurt Vandenberghe, head of the Commission’s climate division, told journalists in Brussels that officials are “assessing the most effective methods to guard against carbon leakage” and considering all available options. The proposal aims to balance climate ambition with industrial competitiveness concerns raised by manufacturers.

The slower reduction pace would give companies more time to adapt production processes and invest in low-carbon technologies. However, it also delays the point at which zero emissions become mandatory for covered sectors. This creates a longer transition period but reduces the immediate pressure that higher carbon prices would otherwise impose on emission reductions.

Expansion of free permit allocations

The most substantial change involves expanding free allowances to cover indirect emissions, particularly electricity consumption. Currently, the EU ETS only provides free permits for direct emissions from industrial processes. Including indirect emissions would significantly increase the value of free allocations.

According to Reuters, this change could deliver approximately €4 billion in additional free permits between 2026 and 2030. The calculation method would incorporate electricity use into benchmark calculations, raising the total allowance each facility receives. As a result, energy-intensive manufacturers would face lower net compliance costs despite rising permit prices in the secondary market.

Additionally, the Commission proposes fast-tracking changes to fallback benchmarks, which determine free allocations based on heat production and fuel consumption. These adjustments could grant an extra €6 billion in free permits starting 1 January 2026. Together, these measures represent roughly €10 billion in cost relief for European industry over the next four years.

Extension of permits beyond CBAM implementation

The Carbon Border Adjustment Mechanism introduces tariffs on carbon-intensive imports from countries without equivalent carbon pricing. The CBAM was designed to replace free allowances, creating a level playing field between European producers and foreign competitors. Under the original plan, free permits would phase out completely when CBAM takes full effect in 2034.

The new proposal seeks to extend free allowances for CBAM-covered sectors beyond 2034. This dual protection system would shield European manufacturers from both import competition and direct carbon costs simultaneously. However, critics argue this approach undermines the CBAM’s purpose and reduces incentives for domestic emission reductions.

Commission officials have not specified how long this extended protection would last. The ambiguity creates planning uncertainty for businesses making long-term investment decisions. Nevertheless, the proposal signals that Brussels prioritizes industrial retention over strict adherence to the original carbon pricing architecture.

Political resistance from member states

Six EU countries have reportedly opposed the proposal, requesting that free permit levels be frozen at 2025 volumes. Bulgaria, Czech Republic, Greece, Poland, Romania and Slovakia cite concerns about energy prices and industrial competitiveness in their regions. These nations host significant heavy industry sectors that would face substantial costs under the current reduction trajectory.

This political friction highlights tensions between wealthier Western European states and Central and Eastern European members. The latter group relies more heavily on carbon-intensive industry and has fewer resources to support rapid industrial transitions. Consequently, any final agreement will require compromise between climate ambition and economic development concerns.

The Commission aims to reach a deal during the first quarter of 2027. This timeline allows for negotiations among member states and approval through the European Parliament. However, the complexity of balancing competing interests suggests the process could extend beyond this target date. Meanwhile, businesses face continued uncertainty about the regulatory framework that will govern their operations through the 2030s.

What UK businesses need to consider

These EU developments have several implications for UK companies, particularly those in manufacturing, energy-intensive sectors and international supply chains. First, changes to EU carbon pricing affect the competitive position of UK exporters selling into European markets. If European competitors receive expanded free allowances while UK firms pay full carbon costs domestically, this creates an uneven playing field.

Second, UK businesses with European operations must plan for potentially different carbon compliance costs than previously anticipated. The extended timeline and increased free allocations would reduce immediate financial pressure but could affect long-term decarbonization investments. Companies may need to revisit capital expenditure plans and technology adoption strategies based on the final policy outcome.

Third, the proposal influences broader discussions about carbon pricing mechanisms globally. As other jurisdictions consider implementing or adjusting their own systems, the EU’s approach provides a reference point. UK policymakers monitor these developments when reviewing domestic carbon pricing policies and considering alignment or divergence from European approaches.

Furthermore, supply chain partners and customers in the EU may adjust their own sustainability requirements based on changing regulatory pressures. If European manufacturers face less stringent immediate reduction requirements, they may alter the emissions reduction expectations they place on suppliers. Conversely, the extended timeline could provide more opportunity for collaborative supply chain decarbonization projects.

Finally, businesses preparing for public sector tenders should note that procurement requirements often reference carbon reduction commitments and compliance with trading schemes. Understanding how the EU ETS evolves helps companies position themselves for contracts that require demonstrated environmental performance. Our sustainable procurement support services can help businesses navigate these requirements effectively.

Eight key points about the proposed changes

• The European Commission will publish draft ETS revisions on 17 July 2026, with negotiations targeting agreement by March 2027.
• The linear reduction factor will decrease from the current 4.3% annual cut, extending permitted emissions into the 2040s instead of eliminating them by 2039.
• Free allowances will expand to cover indirect emissions including electricity consumption, providing approximately €4 billion in additional permits between 2026 and 2030.
• Adjusted fallback benchmarks could deliver an extra €6 billion in free permits starting 1 January 2026, benefiting heat and fuel-intensive processes.
• Free permits for CBAM-covered sectors will continue beyond the mechanism’s full implementation in 2034, creating dual protection for European industry.
• Six EU member states have resisted the proposals, requesting frozen permit allocations due to energy cost concerns.
• The changes aim to prevent carbon leakage and protect European industrial competitiveness against global rivals with weaker climate regulations.
• The revised system balances the EU’s 2040 target of 90% overall emission reductions with extended transition periods for heavy industry sectors.

Balancing climate goals with industrial competitiveness

The proposed overhaul reveals fundamental tensions in climate policy design. Strong carbon pricing mechanisms create powerful incentives for emission reductions through market signals. However, when prices rise significantly, they can disadvantage domestic industry relative to international competitors operating under different rules. The Commission’s proposals attempt to resolve this tension by maintaining climate targets while providing more gradual compliance pathways.

From a business perspective, the extended timeline offers advantages and disadvantages. Additional time for transition reduces immediate capital requirements and allows more measured technology adoption. Companies can align decarbonization investments with normal asset replacement cycles rather than forcing premature retirement of functioning equipment. This approach particularly benefits sectors where low-carbon alternatives remain expensive or technologically immature.

However, slower mandatory reductions may delay innovation and technology development. When compliance costs remain manageable through free allocations, the financial case for investing in cleaner processes weakens. Consequently, European industry might lag behind competitors in regions where stricter policies or carbon prices drive faster technological advancement. This creates strategic risks over the longer term despite providing near-term cost relief.

UK businesses should consider how these dynamics affect their own decarbonization strategies. Even if immediate regulatory pressure remains moderate, companies that move faster on emissions reduction may gain competitive advantages through improved efficiency, enhanced reputation and better positioning for future policy changes. Our net zero program helps businesses develop practical carbon reduction strategies aligned with both current requirements and anticipated future regulations.

Additionally, the proposal highlights the growing importance of carbon accounting and reporting capabilities. As systems become more complex, with differentiated treatment of direct and indirect emissions, accurate measurement becomes essential for compliance and cost management. Businesses lacking robust carbon reporting systems may struggle to optimize their position within evolving regulatory frameworks.

Understanding the wider policy context

These ETS revisions sit within broader discussions about European industrial policy and climate leadership. The EU has positioned itself as a global climate leader, establishing ambitious targets and pioneering carbon pricing mechanisms. However, this leadership creates economic challenges when other major economies maintain less stringent policies.

The United States, China and other manufacturing powers have different approaches to industrial carbon costs. Consequently, European manufacturers face higher production costs for equivalent output. The proposed changes acknowledge this reality, attempting to preserve European industrial capacity while maintaining long-term climate commitments. Whether this balance proves sustainable remains uncertain.

For UK observers, these discussions resemble domestic debates about climate policy ambition versus economic competitiveness. The UK operates its own emissions trading system following Brexit, with similar challenges around protecting energy-intensive industries while driving decarbonization. Lessons from the EU’s approach inform ongoing UK policy development, particularly regarding free allocation methodologies and interaction with border adjustment mechanisms.

International coordination on carbon pricing remains limited despite its importance for preventing leakage and maintaining fair competition. The EU’s struggles to balance these objectives demonstrate the complexity of designing effective climate policy in a globalized economy. UK businesses operating internationally must navigate this fragmented landscape, managing different carbon costs and compliance requirements across jurisdictions.

Where to find additional information

The European Commission will publish full details of the proposal on 17 July 2026 through its official EU ETS information page. This resource provides technical documentation, impact assessments and background materials explaining the rationale for proposed changes.

For current EU ETS rules and compliance requirements, the European Commission climate action website maintains comprehensive guidance documents. These materials help businesses understand existing obligations while monitoring potential changes.

UK businesses should also monitor guidance from the Department for Energy Security and Net Zero, which oversees the UK Emissions Trading Scheme. While the UK and EU systems operate independently, policy developments in either jurisdiction often influence the other.

The Institute of Environmental Management and Assessment provides professional guidance on carbon management and compliance for UK practitioners. Their resources help businesses develop capabilities needed to navigate evolving carbon pricing systems effectively.