EU carbon market reform battle lines drawn as parliament enters the fray

The European Parliament's lead negotiator on the EU Emissions Trading System revision is pushing for a smarter emissions reduction path, stricter investment conditions on free allowances and a more powerful role for ETS revenues in driving down electricity costs ahead of trilogue talks following the Commission's landmark July 17 proposal.

Peter Liese, the German center-right MEP from the European People's Party steering the ETS file as rapporteur for the Environment Committee, presented a draft report Sept. 11, setting the parliament's negotiating position on a reform that will shape European carbon prices and industrial investment decisions for the next two decades.

Liese is broadly supportive of the commission's direction but insists the proposal needs sharpening in several areas. He is unambiguous that the ETS itself is not negotiable.

"The discussions of the beginning of the year are over," he said at a press briefing. "Those who say stop the ETS, abolish the ETS, I don't think they have any chance to succeed. The ETS is here to stay."

But he was equally clear that the system needs careful handling.

"If you put it too tight, it may break," he said, warning that carbon leakage could become a growing problem if free allowances are cut without the enabling conditions for decarbonization being in place.

The commission's July 17 proposal was itself a far-reaching overhaul, slowing the pace of emissions cuts beyond 2030, delivering €6 billion in additional free permits to manufacturers, establishing a new €100 billion Industrial Decarbonization Bank, and introducing controlled access to carbon removals and international credits.

EU Allowance prices rose sharpy few days after the EC's proposal, with December 2026 EUAs trading above €86/mt of CO2 equivalent on July 22. Platts, part of S&P Global Energy, last assessed EU Allowances at €85.84/mtCO2e on Sept. 10, the highest since July 22.

Linear reduction factor

At the heart of Liese's position is a proposed adjustment to the linear reduction factor, the annual rate at which the ETS cap on total emissions declines.

The commission proposed an LRF of 3.7% for 2031-2035, falling to just 1.7% for 2036-2040, down from the current 4.3% rate. Liese accepts the logic of near-term relief but argues the commission's back-end trajectory is too lenient, leaving insufficient ambition in the years that matter most for the 2050 climate neutrality target.

His solution is a split trajectory, with a 3.4% LRF in the first five years of the new period stepping up to 2.3% in the second half.

The adjustment is designed to give industry near-term breathing room while preserving a credible pathway to climate neutrality and, crucially, releasing allowances beyond 2039, the year at which the cap under the current scheme would reach zero.

Liese also wants the Market Stability Reserve modified to reduce price volatility, citing episodes where political statements triggered sudden price collapses or sharp spikes.

More predictable carbon pricing, he said, benefits both frontrunners who have already invested and those not yet able to decarbonize.

The proposal puts him at odds with Germany, which, in Council working party documents, called for keeping the LRF at 4.4% until 2035, a harder near-term line, while also seeking to suspend MSR invalidation until 2030.

France and Italy have separately raised concerns about the predictability of benchmark reductions across the two sub-periods, reflecting a broader anxiety about long-term investment certainty.

Free allowances and conditionality

Driving much of Liese's thinking on free allowances is a conviction that the ETS must become a more powerful engine for driving down electricity costs across the continent.

"We must do everything we can to ensure that electricity prices fall," he said. "EU countries that get their electricity primarily from climate-neutral domestic energy sources, such as Portugal, Sweden and Finland, have relatively low electricity costs compared to Germany and Italy, which are heavily dependent on fossil fuels. Therefore, emissions trading must provide stronger incentives than before for investment in domestic clean energy."

To that end, Liese is calling for 75% of ETS revenues to be reinvested in ETS sectors, up from the 50% proposed by the commission, with a dedicated sub-quota for energy-intensive industries at risk of carbon leakage.

On free allocations, Liese calls for an increase beyond the commission's proposed 47% uplift compared to the current system, particularly for the period up to 2030 and for sectors covered by the Carbon Border Adjustment Mechanism.

But he is insisting those allowances come with conditions and is prepared to resist industry lobbying that seeks unconditional relief. "Industry was shouting, we need free allowances because we want to invest in decarbonization. I heard this not 10 times, not 20 times, more than 50 times, people told me that. And now when we say, yes, you get the free allowances when you invest, they are complaining."

This position could set up a direct confrontation with several member states. Poland has called conditionality "illogical and counterproductive," arguing that free allocations exist solely to level the playing field against non-EU producers.

Italy warned that the implementation timetable does not give investments enough time to generate measurable reductions during the 2031-2035 reference period. France said any conditionality "should remain simple to implement and aim to limit the administrative burden."

With parliament set to adopt its formal negotiating mandate in the coming weeks, and the distance between institutions already visible, the path to agreement on the world's most mature carbon market could be hard-fought.