EU ETS reform 2026: free allowances, removals and Europe's industrial bargain

The European Commission has proposed the biggest redesign of the European Union Emissions Trading System (EU ETS) since the current decade's reforms. The carbon cap would keep tightening after 2030, but free allowances, industrial funding, permanent removals, waste incineration and international transport would all work differently.

The proposal, published on 17 July 2026, is the first major piece of legislation intended to turn the European Union's adopted 2040 climate target into post-2030 carbon-market rules. It is not final law. The European Parliament and member states now have to negotiate it.

One question sits beneath the package: how does Europe keep a shrinking supply of allowances credible without leaving energy-intensive industry with a carbon price and no workable route to invest?

The Commission's answer is not to loosen the cap. Instead, it offers a broader bargain. Industrial protection continues beyond 2030, but more of it is linked to decarbonisation plans. Carbon-market value is channelled into a proposed EUR 100 billion Industrial Decarbonisation Bank. Permanent removals enter through a controlled public purchasing route, while waste incinerators and more international transport emissions move closer to the system.

The proposal at a glance

The cap changes without abandoning the 2040 target

The European Union Emissions Trading System (EU ETS) limits the emissions allowed from covered power plants, factories, airlines and shipping companies. Each allowance permits one tonne of carbon dioxide equivalent emissions, and the total number available falls over time.

The 2026 proposal would set a new reduction path from 2031. It also reflects the architecture of the EU 2040 climate target: at least an 85% domestic net emissions reduction compared with 1990, with the possible use of 260 million high-quality international credits if the required rules and credits are available.

That flexibility does not turn the EU ETS into an international credit market. The Commission says the domestic cap would be calibrated around the agreed climate target, while any international credits would sit within the separate 2040 accounting framework. If the credits are not available, the domestic trajectory would need to carry more of the work.

The Market Stability Reserve would also be reworked. The reserve currently removes surplus allowances from circulation and can release them under defined conditions. A market with far fewer allowances after 2030 may need different thresholds and release rules to avoid erratic liquidity without manufacturing extra long-term supply.

This is where the design becomes delicate. A cap can be environmentally strict and still trade badly if too few allowances circulate. But a liquidity fix that routinely adds supply would weaken the scarcity the market is meant to create. The negotiations will have to separate those two problems.

Free allowances survive, with more conditions attached

Free allocation has always been the uncomfortable part of the EU ETS. It protects industries such as steel, cement and chemicals from losing production to countries with weaker carbon constraints, but it also softens the immediate cost of emitting.

The Commission has chosen continuation rather than a clean break. Free allowances and compensation for indirect electricity costs would remain available after the current trading period. From the five-year allocation period beginning in 2031, however, installations would have to submit plans showing how they will invest in decarbonisation inside the EU.

Under the proposal, 80% of the relevant free allocation would be released in annual tranches once a plan is approved. The remainder would depend on verified implementation. The investment value is tied to the economic value of the allocation, which is intended to make free protection conditional on real capital spending rather than a general promise to improve.

The detail will decide whether this is a demanding bargain or a paperwork exercise. A plan that names a technology but never reaches procurement is not the same as a furnace conversion, electrification project or operating carbon capture system. Benchmarks, verification and consequences for missed delivery therefore matter as much as the existence of a plan.

The proposal also recognises that the Carbon Border Adjustment Mechanism (CBAM) may not remove every carbon-leakage risk. Free allocation in sectors covered by the border mechanism has been due to phase out as CBAM phases in. The new text would leave room to slow or partly revise that withdrawal where residual leakage remains, while still aiming for the phaseout to finish by the end of 2037. The EU CBAM guide covers the current importer and certificate rules.

A EUR 100 billion bank links the carbon market to industrial investment

The Industrial Decarbonisation Bank is the other half of the bargain. The Commission presents it as a EUR 100 billion route for supporting industrial emissions cuts, built around existing and future carbon-market resources rather than a conventional bank balance deposited on day one.

Its first phase, an Investment Booster planned from 2028, would reserve 400 million allowances. Projects could receive fixed carbon premia on a first-come, first-served basis, giving businesses a clearer value for each tonne of verified emissions reduction.

From 2031, the toolkit could expand to competitive carbon premia and carbon contracts for difference. Those contracts can bridge the gap between the cost of a low-carbon industrial process and the carbon price it avoids. If a project needs a carbon value above the market price to operate, the contract covers part of the difference under agreed terms.

The headline EUR 100 billion will move with allowance values and programme design. It should not be read as EUR 100 billion already committed to named factories. The stronger test is whether the bank can support projects that are technically credible, close enough to investment and capable of cutting emissions that the falling cap can no longer accommodate.

Permanent removals enter through a controlled route

The proposal would bring permanent carbon removals into the EU ETS, but not by letting every covered company buy a removal credit instead of an allowance.

The Commission would purchase certified removals produced inside the EU. The cap could then be increased by the corresponding amount, giving the hardest-to-abate sectors limited additional emissions space while the removal balances the added tonne. Quantity and quality limits would be set through further rules.

There is a narrower route for operators using biogenic carbon capture and storage at their own installations. They could count certified permanent storage against fossil emissions from that installation, down to zero. They could not create a negative compliance balance or receive extra allowances for removing more than they emit.

This structure keeps a distinction between a regulated allowance and a carbon removal credit. It also leaves difficult questions open: which methods qualify, how long storage must last, who carries reversal liability, how public purchases are priced and how the system avoids paying for removals that would have happened anyway.

The proposal creates a route, not a settled removals market. Procurement rules and certification standards will decide whether it becomes a disciplined tool for residual emissions or an expensive source of accounting comfort.

Municipal waste would phase into the system from 2031

Large municipal waste incinerators have reported emissions under the EU ETS since 2024, but they have not generally had to surrender allowances. The new proposal would change that.

For plants above the relevant three-tonne-per-hour threshold, allowance surrender would phase in between 2031 and 2034, reaching full coverage in 2034. District-heating installations using waste-to-energy could remain eligible for free allocation under the proposed rules.

The staged start is intended to reduce sudden price shocks and give the sector time to separate fossil and biogenic emissions more accurately. Member states meeting specified recycling and landfill conditions could seek a temporary derogation if equivalent measures achieve the policy objective.

Landfills are not automatically brought into the carbon price. The proposal instead strengthens methane monitoring so policymakers can see whether waste is being diverted from incinerators into disposal routes with their own climate costs.

That boundary matters for councils and waste companies. Pricing incineration can encourage prevention, reuse and recycling, but only if policy prevents waste shifting into a less visible emissions problem.

Aviation and shipping coverage moves outward

Aviation would face wider coverage under the proposal. The EU ETS would apply, where specified, to flights departing for countries in the EU's immediate neighbourhood and to business flights. The Commission also proposes extending the cancellation requirement under the Carbon Offsetting and Reduction Scheme for International Aviation (CORSIA) to 2035.

The two systems are not interchangeable. EU ETS allowances cover regulated European emissions. CORSIA uses eligible carbon credits against part of international aviation growth. The proposal would deduct eligible CORSIA costs from the EU ETS obligation on overlapping routes to reduce double pricing. The CORSIA and EU ETS comparison explains the different units and boundaries.

Shipping changes are aimed partly at evasion. The Commission proposes bringing certain smaller vessels between 400 and 5,000 gross tonnage into relevant rules and strengthening measures against route or company structures designed to avoid coverage. It also leaves room to recognise a future global carbon price agreed through the International Maritime Organization (IMO), rather than charging the same emissions twice.

Revenue from the expanded transport coverage would be directed toward lower-emission fuels and technologies. As with the industrial bank, the value of that support depends on what reaches projects and how quickly cleaner fuels become available at commercial scale.

EU ETS2 is not part of this reform

The package does not rewrite the separate EU ETS2 for buildings, road transport and additional sectors. That system is due to become operational in 2028 and will be reviewed on its own timetable.

Keeping the files separate helps avoid a common confusion. This proposal is mainly about the established EU ETS for power, heavy industry, aviation and shipping after 2030. It does not settle household-facing fuel prices or the operation of the Social Climate Fund.

The negotiations will decide how hard the bargain is

For industrial operators, the immediate work is not to treat every proposal figure as settled compliance law. It is to model how a falling cap, conditional free allocation, CBAM exposure and new funding tools could change investment decisions for the 2031 to 2040 period.

For removals developers, the opening is real but narrow. The buyer in the proposed route is the Commission, the supply must be domestic and permanently stored, and detailed eligibility and procurement rules still have to be written.

For waste, aviation and shipping operators, the package identifies new coverage and a timetable, but negotiations can alter thresholds, derogations and coordination with international schemes.

The central bargain is now visible. Europe intends to make carbon scarcity harder, while returning more of the market's value to factories and technologies that can live within it. Whether that bargain cuts emissions or merely lengthens protection will be decided by the conditions attached to the money.

Official sources

• European Commission: proposal to amend the EU ETS and Market Stability Reserve
• European Commission: impact assessment executive summary
• European Commission: 17 July 2026 post-2030 climate policy package
• European Commission: EU Emissions Trading System
• European Commission: maritime transport companion proposal
• European Commission: reducing aviation emissions
• Feature image: electric steelworks construction at voestalpine Donawitz by Aciarium, Creative Commons Attribution 4.0