ERT Paper on Future of Carbon pricing (ETS & CBAM)

Executive summary

The companies represented by the European Round Table for Industry (ERT) – spanning sectors from (heavy) industry to technology and energy – are united by a shared, yet uneven, exposure to the EU Emissions Trading System (ETS1). As the next ETS1 reform approaches, the debate has become increasingly polarised, with sharply diverging interpretations of both the system’s past performance and its future role in Europe’s decarbonisation strategy. These differences are not abstract – they reflect fundamentally different industrial realities, cost exposures, and transition pathways across sectors, technologies and regions. This paper starts from that divergence. Rather than advancing a single narrative, it seeks to provide a clear-eyed stocktaking of where the ETS1 stands today, explain why perspectives at times differ so markedly, and identify a pragmatic way forward that can command broad support across the full diversity of ERT membership.

Over the past two decades, the ETS1 has proven to be one of the EU’s most effective decarbonisation instruments – particularly in the power sector, where a reliable carbon price coupled with comprehensive public support schemes, the availability of cost-competitive technologies, and the ability to pass through carbon costs, have driven substantial emissions reductions. While carbon pricing remains the most cost-effective and market-friendly policy tool available, the next phase of decarbonisation presents fundamentally different challenges. Energy-intensive industries face (significantly) higher abatement costs, often depend on untested emerging technologies and infrastructures that are not yet available at the required scale, and mostly operate in globally competitive markets where additional costs cannot easily be passed through.

As the system tightens towards 2030 and beyond – with a declining cap and the gradual phase-out of free allocation – these structural differences become increasingly consequential. Higher carbon costs alone are unlikely to deliver industrial decarbonisation where the necessary prerequisites are not in place. At the same time, decarbonisation conditions and costs vary widely across sectors and regions, including differences in trade exposure, technological readiness, and access to affordable clean energy across Member States. Without a carefully recalibrated policy framework, there is a material risk of undermining investment certainty – due to a lack of long-term credibility of the system – and further eroding Europe’s industrial competitiveness amid a renewed energy price crisis and intensifying global competition.

Against this backdrop, a successful ETS1 reform should preserve the system’s overall integrity as a market-based decarbonization instrument, while pursuing three core objectives:

1. Ensure a credible carbon pricing trajectory that supports long-term investments while maintaining market liquidity as the cap tightens
2. Provide effective carbon leakage protection through a sector-specific approach combining continued free allocation and indirect cost compensation with a carefully calibrated CBAM, complemented by additional instruments for sectors that cannot be adequately protected by CBAM
3. Systematically reinvest ETS1 revenues in the decarbonisation of the sectors bearing the costs of the scheme, including the necessary (cross-border) infrastructure

Firstly, to better align the ETS1 trajectory with climate neutrality by 2050 and ensure market liquidity post-2030, EU policymakers should:

• Lower the Linear Reduction Factor for the next trading period to better align the ETS1 trajectory with the EU’s 2050 net-zero target, while remaining consistent with the evolution of the EU’s broader climate framework
• Reform the Market Stability Reserve to facilitate market liquidity post-2030 by adjusting its intake and release rules, ensuring non-invalidated allowances can be reintroduced into the market when needed, e.g. via earlier and more gradual releases
• Potentially allow the limited use of high-quality international credits in ETS1, while safeguarding the carbon price signal and environmental integrity, for example through centralized EU-level procurement (e.g. via a reformed MSR)
• Integrate domestic carbon removals into the ETS1 from 2031 onwards, in line with the EU’s Carbon Removals and Carbon Farming (CRCF) Regulation
• Expand the geographical scope of the carbon market within Europe, particularly through a timely linking of the EU and UK ETS

Secondly, EU lawmakers must guarantee an effective carbon leakage protection framework. This entails urgent cross-sectoral improvements to ETS benchmarks and CBAM design, as well as recognising that ETS1 sectors face varying leakage risks and protection challenges depending on their trade exposure and value chain complexity. Policymakers should therefore:

• Refrain from further ETS benchmark updates until the methodology is revised to better reflect industrial realities, for example by increasing the share of ‘best-performing installations’ in the reference group to improve representativeness
• Expand CBAM to downstream products at factual risk of carbon leakage to preserve Europe’s industrial value chains, while also taking into account the rising administrative burden and compliance complexity for EU importers
• Swiftly implement the newly proposed CBAM anti-circumvention safeguards, including measures against harmful resource shuffling as well as the inclusion of pre-consumer steel scrap and all aluminium scrap as a precursor
• Establish a permanent CBAM export solution that maintains full free allocation for the share of EU production destined for exports – covering the entire production process emissions (including upstream), while also protecting downstream sectors
• Slow the free allocation phase-out for CBAM sectors from at least 2028 onwards and recalibrate it to reach zero significantly later than 2034, reflecting the time needed for industry to transform and for a new system to prove its effectiveness
• Revert the CBAM factor to pre-2026 levels (i.e. 100%) if CBAM cannot effectively protect all covered sectors against carbon leakage, as determined by the Commission’s report due before 2028, which shall be based on objective criteria
• Refrain from any horizontal scope extensions until the Commission’s CBAM review report is published, while ensuring any such extension provides effective downstream carbon leakage protection from the outset and is assessed case by case
• Ensure that CBAM is under no circumstances extended to organic chemicals and polymers, whose complexity makes it practically infeasible, while developing alternative carbon leakage protection instruments for the chemical industry
• Potentially move towards a tiered approach that aligns free allocation more closely with sector-specific carbon leakage risks, allowing limited free allocation volumes to be concentrated where they are most needed
• Keep indirect emissions outside CBAM for now and instead prolong indirect cost compensation beyond 2030, extending it to all electro-intensive sectors exposed to global competition and ensuring full compensation of indirect CO₂ costs
• Require all Member States to fully use indirect cost compensation, potentially by mandating it in the ETS Directive and ringfencing national ETS1 revenues accordingly, thereby enhancing visibility for companies seeking to (further) electrify

Finally, to ensure more effective use of ETS1 revenues while avoiding market distortions from frontloading, EU lawmakers and national governments should:

• Dedicate a substantially higher share of (national) ETS1 revenues to decarbonising the sectors bearing the costs of the scheme, including necessary energy infrastructure upgrades
• Use the Industrial Decarbonisation Bank to organise EU-wide auctions that avoid lengthy state aid procedures and provide CAPEX and temporary OPEX support, financed by ringfencing national ETS revenues for the best domestic projects
• Avoid financing the ‘ETS Investment Booster’ through frontloading future auction volumes to prevent ‘REPowerEU-like’ market distortions, and instead rely primarily on EU-level financing solutions similar to the EIB’s ETS2 frontloading facility