Debate intensifies over free emission allowances in the EU ETS
BusinessEurope, the main business lobby of the European Union, has called on the Commission to maintain free emission allowances for industry for longer, ahead of the 2026 revision of the EU Emissions Trading System (EU ETS).
The Commission is expected to table the ETS revision proposal in the third quarter of this year. Carbon-intensive industries and several Member States, including Italy, are increasing pressure on Brussels to soften key elements of the system.
The EU ETS, established in 2005, covers energy-intensive sectors, power generation, intra-European aviation and maritime transport. It applies to around 40% of total EU greenhouse gas emissions and has already demonstrated its effectiveness as a tool for reducing emissions.
The system requires power plants and factories to purchase CO₂ permits, effectively paying for their pollution. A central issue in the upcoming revision concerns whether to modify the scheme of free emission allowances, which mitigates pollution costs for industry. Under current rules, these free permits are to be phased out by 2034.
Industry pressure and calls for flexibility
BusinessEurope, which brings together national industrial associations such as Germany’s BDI and Poland’s Lewiatan, has urged the EU not to make free permits conditional on corporate investment in energy efficiency. Italy’s Confindustria has also criticised the ETS, calling on Europe to suspend the system and review its functioning.
“The Commission should reconsider the planned phase-out of free allowances across all sectors,” BusinessEurope stated. The lobby also suggested expanding the list of sectors eligible for free emission allowances, maintaining the framework for indirect cost compensation beyond 2030 and extending it to more Member States.
The message is clear: recognise the difficult state of EU competitiveness and adjust the ETS revision to post-2030 challenges.
Linking free allowances to industrial decarbonisation
The Commission, however, has planned to phase out free permits in parallel with the introduction of the carbon border adjustment mechanism on imports. Brussels argues that maintaining both systems would amount to double compensation for domestic industry and could breach World Trade Organization rules.
According to an internal Commission document reported by Reuters, officials are examining various options for reforming free emission allowances, including linking them directly to industrial decarbonisation performance.
The Italian government’s challenge to the ETS
A group of 150 climate and energy transition scientists has appealed to the Italian government not to weaken European decarbonisation instruments. “The government’s attack on the ETS risks undermining a policy that has already demonstrated its ability to reduce emissions in regulated sectors, stimulate innovation and support industrial transition at sustainable costs,” said Stefano Caserini of the University of Parma.
Italy’s recently approved Energy Decree provides for separating the cost of ETS certificates from electricity price formation in an effort to curb energy costs for households and businesses. The Commission has launched an assessment of the measure’s compatibility with EU rules.
ETS effectiveness and economic impact
The think tank Bruegel considers the EU ETS an ally, rather than an obstacle, to industrial competitiveness. Empirical evidence suggests the ETS reduced total EU emissions by 14–16% between 2005 and 2020, with only modest impacts on corporate profitability and employment.
The system works not only because it prices carbon today, but because companies expect the emissions cap to continue tightening. Managing expectations is therefore essential to preserving credibility.
Macroeconomic assessments indicate limited overall effects on GDP and inflation, though impacts have varied by country and sector. Carbon-intensive economies in Central and Eastern Europe have faced relatively higher adjustment pressures, highlighting the importance of instruments such as the EU Modernisation Fund and the Just Transition Fund. Overall, however, the ETS has succeeded in reducing emissions efficiently without placing an excessive burden on the competitiveness of European industry.
Did generous free allocations support transformation?
In Phases I (2005–2007) and II (2008–2012), free emission allowances dominated. However, carbon leakage criteria were broad, extending protection beyond genuinely exposed sectors. This resulted in over-allocation combined with widespread free distribution.
Until 2012, both the power sector and energy-intensive industries received free allowances in quantities exceeding their actual emissions. Only with the start of Phase III (2013–2020) did auctioning become the default method for electricity generation, drastically reducing the volume of free allowances and finally creating a binding cap. Companies in the metals, minerals, chemicals and paper sectors received more allowances than their verified emissions, generating substantial windfall profits.
Since 2013, the system has generated more than €245 billion in auction revenues. In 2024 alone, total revenues amounted to €39 billion. Although the rules stipulate that 100% of these revenues must be used to finance climate and energy initiatives, it has emerged that these resources have not necessarily been used to support industrial transformation.
Germany provides a notable example: in 2023 it was the largest beneficiary of auction revenues (€7.6 billion), channelled into a special fund. However, there is evidence that part of the spending, up to 30% in 2025, may have been directed towards initiatives and projects contrary to climate objectives, such as energy subsidies favouring short-term price relief over long-term decarbonisation.
How to require companies to invest in decarbonisation
Bruegel suggests that policymakers should anchor the debate in concrete evidence provided by Member States on the results achieved by the ETS, so that the system evolves from a cap-and-trade model to a cap-and-invest approach, capable of driving Europe’s industrial transformation.
Rather than diluting the ETS, policymakers should:
- Require companies to invest in decarbonisation initiatives in order to qualify for free allowances.
- Better align Member States’ spending of auction revenues with decarbonisation projects.
- Ensure that the share of revenues managed at EU level is expanded and used to finance investment and industrial competitiveness across the Union.