Once hailed as a quiet success of EU climate policy, emissions trading is entering its most contested phase yet. With carbon prices climbing and industry under pressure, the system designed to cut pollution is now reshaping Europe’s competitiveness debate. And while some EU leaders push for change, the Commission is signalling reform.
“European industry is being destroyed by ETS I” and “ETS II is intended to harm citizens.” These are the words of Czech Prime Minister Andrej Babiš, shared on his social media. While the Czech leader is known for using stark language, he is not alone in questioning the system. Slovak Prime Minister Robert Fico has voiced similar concerns, arguing that the emissions trading system (ETS) has caused “enormous economic damage”. Together with Babiš, he has called for the issue to be raised at this month’s meeting of EU leaders.
ETS Directive revision by mid-2026
Mr Babiš’s and Mr Fico’s criticisms come as Europe’s flagship climate instrument, the ETS is entering a pivotal phase. The Commission is expected to deliver a revision of the EU ETS Directive by mid-2026. Carbon pricing is no longer only an environmental tool but a core component of Europe’s industrial, competitiveness and geopolitical strategy.
In practice, the EU ETS works by steadily increasing the cost of emitting carbon for companies covered by the system. Each year, fewer emission allowances are available, and firms must either buy them on the market or reduce their emissions. This tightening constraint has shaped corporate investment and operating decisions across Europe’s power and industrial sectors, contributing to a roughly 47 per cent reduction in emissions since 2005.
Beyond a tool for climate policy, the ETS is now firmly embedded in Europe’s competitiveness and industrial policy debate, reflecting a broader shift in EU policy. Carbon pricing is no longer treated as a stand-alone environmental signal, but as a structural—and controversial—element of Europe’s economic model, sitting alongside the Clean Industrial Deal, the Competitiveness Compass and the Carbon Border Adjustment Mechanism (CBAM).
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What has changed
In its early phases, ETS showed some negative effects on the EU’s competitiveness. These were mainly linked to higher energy and compliance costs for energy-intensive, trade-exposed sectors, as well as to distortions caused by uneven national allocation rules. However, these impacts were limited in scale, uneven across sectors and member states, and largely related to transitional design features rather than to emissions trading as such.
What is different today is not the principle of emissions trading, but the context in which it operates. The EU ETS is no longer a marginal or experimental policy. It is a central pillar of the EU’s climate framework, covering a growing share of emissions, operating with a steadily tightening cap, and interacting directly with energy markets, industrial investment decisions and trade policy.
In the first two trading phases, the system operated under relatively generous caps, extensive free allocation—meaning many companies received emission allowances at no cost—and limited global carbon pricing. Those conditions softened its impact on industry.
Today, and even more so after 2030, those buffers are shrinking. The cap is tightening faster, free allocation is being reduced, and carbon prices are structurally higher and more volatile. At the same time, European industry is facing persistently higher energy costs than many global competitors.
This combination is what has brought competitiveness back to the centre of the ETS debate.
Better alignment with industrial policy
Much of the early discussion around competitiveness focused on carbon leakage—the risk that companies would relocate production outside the EU to avoid carbon costs. While empirical evidence suggests this risk has so far been limited, stakeholders increasingly argue that the challenge ahead is less about relocation and more about investment decisions.
The EU has gradually strengthened its carbon leakage framework through free allocation, indirect cost compensation and, more recently, CBAM. The latter applies a carbon price to certain imports to ensure that foreign producers face similar carbon costs to those paid by EU industry. However, CBAM does not cover all exposed sectors, and free allocation is being phased down more rapidly in some industries than others.
Even well-designed carbon pricing can become problematic if it is not aligned with broader industrial policy. – Bruegel’s report on ETS
As a report by think tank Bruegel notes, the key question is whether the ETS continues to support cost-effective decarbonisation, or whether it begins to discourage investment in Europe by adding uncertainty and cumulative cost pressure. In a context of high energy prices, tighter capital markets and global competition for clean-tech investment, even well-designed carbon pricing can become problematic if it is not aligned with broader industrial policy.
This is why debates around the post-2030 ETS focus less on whether emissions trading ’works’, and more on how its parameters interact with real-world industrial constraints.
Cost exposure, investment predictability
From a competitiveness perspective, three issues now dominate discussions around the ETS. First, it is the cost exposure. Carbon costs increasingly sit on top of already high electricity and fuel prices. For energy-intensive sectors with limited ability to pass costs through to global markets, this creates a cumulative disadvantage—even where direct ETS compliance costs remain partially cushioned by free allocation.
Investment predictability is also at the center of the debate. Industrial decarbonisation requires large, long-term investments. Companies repeatedly stress that volatile carbon prices, changing benchmarks and conditionalities attached to free allocation increase regulatory risk, making it harder to justify capital-intensive projects in Europe.
Finally the credibility of protection mechanisms is under scrutiny. Instruments such as free allocation and CBAM are intended to prevent carbon leakage, but their interaction with a tightening ETS is still evolving. Whether they provide sufficient, predictable protection in practice—rather than in theory—is a central question heading into the 2026 revision.
What next?
Key issues expected in the 2026 revision include the post-2030 cap trajectory, the pace and conditions of free allocation, the role of the Market Stability Reserve, and how the ETS interacts with persistently high energy prices and instruments such as CBAM.
