The European Commission has proposed slowing the pace of emissions reductions under the EU carbon market from 2031 and extending free pollution allowances to industry through 2038, drawing criticism that the bloc is weakening its flagship climate tool.
The proposal, presented on 17 July, marks the most significant overhaul of the Emissions Trading System since the Fit for 55 package. It comes after months of pressure from member states and industrial firms arguing that carbon costs threaten competitiveness, while climate advocates warn the changes jeopardise Europe’s 2040 target.
Free Allowances Extended to 2038
Under the commission’s plan, free allowances — which let companies emit a tonne of CO2-equivalent without paying — would continue until 2038, four years beyond the phase-out date of 2034 agreed in previous legislation. The extension is conditional: firms must submit decarbonisation investment plans for their EU operations.
From 2031, 80% of free allowances would go only to companies with approved investment plans. EU climate commissioner Wopke Hoekstra called the approach “savvy” and business-friendly at a press conference, framing it as relief for industry while preserving the system’s climate role.
Currently, 43% of allowances are given free and 57% are auctioned. The EU raised €43bn in auction revenue in 2025. Free allocations were designed to prevent carbon leakage — firms relocating to countries with weaker climate rules — but critics argue they dilute the price signal that drives decarbonisation.
Slower Path to Zero
The proposal also slows the annual reduction of the emissions cap, the mechanism that gradually tightens the limit on covered sectors until emissions reach zero. The commission did not specify the new trajectory, but officials confirmed the descent would ease from 2031 onward.
The ETS covers roughly 40% of EU emissions across electricity generation, heavy industry, aviation and maritime sectors in all 27 member states plus Iceland, Liechtenstein and Norway. Emissions in these sectors have halved since the system launched in 2005.
The review aligns the carbon market with the EU’s goal of cutting emissions 90% below 1990 levels by 2040. Whether the slower trajectory still meets that goal is now the central question for negotiations.
Electricity Target and Fossil Fuel Savings
Alongside the ETS proposal, the commission set a new target for electricity to reach 46% of EU energy consumption by 2040, double the current 23%. The commission estimates this could reduce spending on imported fossil fuels by €260bn annually.
The electricity target signals where the commission expects the fastest decarbonisation to occur, even as it eases pressure on industrial sectors covered by the carbon market.
Divided Member States
The proposal reflects deep divisions among EU countries. In March, ten states including Italy, Hungary and Poland wrote to the commission calling the ETS an “existential risk” for key industries, with Italy previously demanding outright suspension.
Conversely, Spain, the Netherlands and five others urged the commission to “resist gutting” the system, arguing that a strong ETS provides investment predictability and regulatory stability. Dozens of investment organisations echoed that message, calling policy stability “the cheapest investment stimulus available to the EU.”
Climate thinktank E3G warned that weakening the system as a short-term economic fix could “undermine investment signals and leave Europe more exposed to fossil-fuel shocks.” Carbon Market Watch said “now is not the time to backslide.”
What Happens Next
The proposal now enters negotiations with the European Parliament and Council, where member state divisions will shape the final text. Expect intense debate over the 2038 free allowance end date and the investment plan conditions, which will determine whether the extension drives decarbonisation or merely delays it.
Watch for parliament amendments seeking a tighter cap and earlier phase-out, and for industry-heavy states to push for further concessions. The outcome will signal whether the EU prioritises near-term industrial relief or long-term climate credibility — and whether the carbon market remains the “cornerstone” of European climate policy or becomes a diluted version of itself.
— Rachel Greenwood, climate desk, AXO News