EU considers extending free carbon permits under ETS

Commission review puts industry carbon costs back in spotlight

The European Commission is preparing to revisit how much free pollution allowance European industry receives under the EU Emissions Trading System. A formal review due in July 2026 will examine whether to maintain, expand, or tighten the allocation of free carbon permits to energy-intensive sectors. The outcome will affect manufacturers across steel, cement, chemicals, and other heavy industries that compete internationally while facing rising carbon costs at home.

This review arrives amid sustained pressure from industry groups and several member states. They argue that high energy prices and global competition require continued support. However, environmental advocates warn that extending free permits undermines the carbon price signal needed to accelerate decarbonisation. For UK businesses trading with the EU or monitoring policy trends, the debate offers a preview of tensions likely to surface in any future UK carbon pricing reforms.

The stakes are significant. Free allocation currently shields energy-intensive manufacturers from the full cost of their emissions. Critics say this delays the shift toward cleaner production. Supporters counter that removing protection too quickly risks pushing manufacturing outside Europe to countries with weaker climate rules. This phenomenon, known as carbon leakage, remains central to the policy argument.

The review sits within a broader package of ETS reforms already under way. Member states recently approved updated benchmarks for calculating free allowances between 2026 and 2030. According to the Commission, these changes will deliver approximately €4 billion in additional free permits over that period. That provides near-term relief without resolving the longer-term question of whether free allocation should continue beyond the current phase-down schedule.

Free permits and the polluter-pays principle

The EU Emissions Trading System operates by capping total emissions and requiring companies to hold permits for each tonne of carbon dioxide they release. Some permits are auctioned. Others are allocated free of charge to specific sectors. The logic behind free allocation is straightforward. Industries that face international competition and cannot easily pass costs to customers might relocate production to regions without carbon pricing. This would harm European jobs without reducing global emissions.

Under current rules, free permits are distributed according to product-specific benchmarks. These benchmarks reflect the emissions performance of the cleanest installations in each sector. Companies that operate below the benchmark can sell surplus allowances. Those above it must buy additional permits. The system is designed to reward efficiency while maintaining a safety net for trade-exposed industries.

From 2026, free allocation is scheduled to become conditional on energy efficiency improvements and credible decarbonisation efforts. This adds a performance element to what has traditionally been a protective measure. Aviation is set to lose free allocation entirely by 2026. Other sectors face a gradual phase-down aligned with the rollout of the Carbon Border Adjustment Mechanism, which begins applying import charges to certain goods from non-EU countries.

Reuters reports that the Commission is considering multiple options. These range from keeping the current system largely unchanged to making free permits more tightly linked to low-carbon investment. Some earlier internal proposals included a full phase-out over time, though political resistance makes that outcome unlikely in the near term. The final shape of the reform will emerge from the July 2026 review, informed by industry lobbying, member state preferences, and climate policy objectives.

CBAM rollout creates overlapping pressures on heavy industry

The Carbon Border Adjustment Mechanism introduces a parallel dynamic. CBAM will impose charges on imports of steel, cement, aluminium, fertilisers, hydrogen, and electricity based on their embedded carbon emissions. The aim is to prevent carbon leakage by ensuring that foreign producers face costs comparable to those borne by EU manufacturers. As CBAM phases in between 2026 and 2034, free allocation for the covered sectors is scheduled to phase out correspondingly.

This creates a crossover period during which both mechanisms operate simultaneously. Domestic producers will see free permits decline while their foreign competitors begin facing border charges. The transition is intended to be gradual, but it compresses the timeline for heavy industry to adapt. Companies that have delayed investment in low-carbon processes now face dual pressure from falling free allocation and rising compliance costs under tightened ETS caps.

The Commission has said the updated benchmarks approved by member states will ease some of this pressure. The additional €4 billion in free permits over five years provides breathing room. Nevertheless, the underlying trajectory remains clear. Free allocation is diminishing, and the expectation is that manufacturers will either decarbonise or pay for emissions through permit purchases or CBAM charges when sourcing inputs from abroad.

For businesses outside the EU, CBAM matters because it affects the cost structure of goods sold into European markets. UK exporters in CBAM-covered sectors will need to track and report the carbon intensity of their products. From 2026 onward, they may also face financial charges if UK carbon pricing is not recognised as equivalent to the EU system. The July 2026 ETS review will offer clues about how strictly the EU intends to enforce the polluter-pays principle, both domestically and at its borders.

What the figures and timelines tell us

Several specific details frame the current debate. The following points summarise the key facts that UK businesses should understand when assessing the direction of EU carbon policy and its potential read-across to domestic regulation.

• The European Commission will publish its formal ETS review on 15 July 2026, covering options for free permit allocation beyond the current phase-down schedule.
• Member states have already approved updated carbon benchmarks for 2026 to 2030, expected to generate approximately €4 billion in additional free allowances across that period.
• Free allocation becomes conditional from 2026 on demonstrated energy efficiency and decarbonisation measures in eligible sectors.
• CBAM applies import charges to steel, cement, aluminium, fertilisers, hydrogen, and electricity, phasing in fully between 2026 and 2034 as free permits for those sectors are withdrawn.
• The ETS has been tightened to cut covered-sector emissions by 62 per cent by 2030 compared with 2005 levels, according to Commission projections.
• Aviation free allocation is scheduled to end by 2026 under reforms already adopted by the EU.

Competitiveness concerns versus climate ambition

The core tension in this policy debate is whether protecting industrial competitiveness slows necessary decarbonisation. Manufacturers argue that high energy costs, competition from less regulated economies, and insufficient low-carbon infrastructure justify continued free allocation. They point to the risk that tightening the ETS too quickly will drive production offshore without reducing global emissions. Some member states, particularly those with large industrial sectors, have echoed these concerns in discussions with the Commission.

Environmental groups and climate policy advocates take a different view. They argue that free permits dilute the carbon price signal that drives investment in cleaner technologies. When companies receive allowances at no cost, the incentive to reduce emissions weakens. The result, critics say, is slower progress toward net zero and a missed opportunity to accelerate industrial transformation. They also note that extending free allocation creates windfall profits for some firms that can pass costs to customers while still holding permits they did not pay for.

The Commission’s stated position reflects an attempt to balance these competing pressures. Internal documents quoted by Reuters describe the review as examining ways of providing protection while assisting industry in its decarbonisation efforts. This language acknowledges both the competitiveness concern and the climate imperative. The practical challenge is designing a system that addresses both without sacrificing either.

For UK policymakers and businesses, the EU’s choices matter because they set expectations for carbon pricing in comparable economies. The UK Emissions Trading Scheme operates on similar principles, and any significant shift in EU policy is likely to inform domestic discussions. If the Commission extends free allocation substantially, pressure may build in the UK to follow suit. Conversely, if Brussels tightens the rules, UK industry may face divergent competitive conditions depending on how domestic policy evolves.

Implications for UK manufacturers and exporters

UK businesses in energy-intensive sectors should monitor the July 2026 review closely. Those exporting to the EU will be directly affected by CBAM, which requires reporting of embedded emissions and may impose financial charges if UK carbon costs are deemed insufficient. The extent to which the EU preserves free allocation for its own industry will influence the competitive landscape. Generous EU free permits could place UK exporters at a disadvantage unless equivalent support is provided domestically.

Manufacturers operating in both the UK and EU will face complexity if the systems diverge. Different rules on free allocation, benchmarking, and conditionality create administrative cost and strategic uncertainty. Supply chains that span both jurisdictions must navigate overlapping compliance requirements. Companies making long-term capital investment decisions need clarity on whether carbon costs will rise predictably or be offset by policy interventions such as extended free permits.

There is also a risk of policy arbitrage. If the EU softens its ETS requirements while the UK maintains or tightens its own, production may shift toward the more lenient regime. Conversely, if the UK offers more generous transition support, EU-based operations might face higher costs. These dynamics are unlikely to resolve quickly, because both systems remain in flux and political pressures differ across jurisdictions.

The broader point is that carbon pricing is no longer a purely domestic concern. Cross-border trade, investment decisions, and supply chain management all depend on understanding how different carbon regimes interact. The EU’s ETS review will clarify whether the bloc intends to accelerate decarbonisation by tightening free allocation or to prioritise competitiveness by extending support. Either outcome will affect UK businesses with European exposure, and it will shape expectations for UK carbon policy in the coming years.

Where to find authoritative updates and guidance

The European Commission publishes detailed information on the EU Emissions Trading System, including policy updates, legislative texts, and consultation documents, at its dedicated ETS page. This is the primary source for tracking the July 2026 review and any subsequent regulatory changes.

For analysis of CBAM implementation and its interaction with free allocation, the Commission’s Carbon Border Adjustment Mechanism page provides official guidance, timelines, and reporting requirements. UK exporters should consult this resource when assessing obligations for goods sold into EU markets.

The UK government’s position on carbon pricing and its relationship with the EU ETS is outlined by the Department for Energy Security and Net Zero at gov.uk. Updates on the UK Emissions Trading Scheme and equivalence negotiations with the EU appear there as policy develops.

Businesses seeking practical support on carbon reporting, emissions reduction, and compliance with UK and EU requirements can access guidance through our compliance services, which cover regulatory obligations and reporting frameworks relevant to both jurisdictions.