EU ETS Phase 1 Reform and Supporting Measures: A Policy Mix for the Decarbonisation of Industry

On 17 July 2026, the European Commission will present its proposal for reforming the European Union Emissions Trading System (EU ETS 1). In one sense, this is a regular review. However, the main aim is to realign emissions trading in view of the EU’s new climate target for 2040. The EU ETS 1 has created crucial framework conditions for the climate-policy successes of the energy sector and industry. Since 2005, emissions covered by EU ETS 1 have fallen by around 49 percent in Germany and by 51 percent across Europe. So far, most of this reduction has come from the energy sector, supported by targeted subsidies for electricity generation from renewable energy and combined heat and power. The burden on industry, which competes internationally with locations that do not face comparable CO ₂ prices, has so far been reduced through free allocation.

This phase is now ending. Free allocation is being phased out. The pressure to adapt is shifting to industry, especially to the basic materials sectors that are difficult to decarbonize. At the same time, the geo-economic conditions for almost all industrial sectors have worsened: the war in Ukraine and the Iran war are making fossil energy more expensive, while Chinese overcapacity and trade-policy disruptions are increasing competitive pressure.

Against this background, this project examines reform options for the EU ETS.  The analysis covers all the key instruments of the system: the cap, the Market Stability Reserve (MSR) and free allocation.

It should also be taken into account that, especially with regard to investments in new facilities, that the incentives of EU ETS 1 are, at least in some areas, not sufficient to enable investments in transformative production processes to the necessary extent. Therefore, in addition to the reform proposals for EU ETS 1 set out above, a set of accompanying measures will also be examined in order to make the necessary investment decisions possible. These two aspects — the reform of EU ETS 1 and the accompanying instruments — are interdependent.