EU leaders urge faster carbon market reform to curb price volatility

EU leaders have called on lawmakers to speed up reform of the carbon market's key supply management mechanism and an updated assessment of a new emissions trading scheme, as Brussels seeks to balance climate ambitions against mounting pressure to shore up industrial competitiveness.

The conclusions from the Oct. 15-16 European Council summit, adopted in the early hours of Oct. 16, direct the European Parliament to "accelerate" ongoing legislative talks on the Market Stability Reserve, the mechanism that controls the supply of carbon allowances in the EU Emissions Trading System, with the explicit aim of "moderating" what leaders described as "excessive price volatility," according to the summit text.

The summit conclusions frame the push for reform squarely within the EU's broader competitiveness agenda, with leaders reiterating the need for a carbon market that is "well-functioning, transparent and predictable," while also effectively protecting European industry against carbon leakage.

Leaders stopped short of calling for a weakening of the ETS itself, stressing the need to preserve "the essential role of the ETS in the climate and energy transition through a market-based price signal for carbon emissions that drives investment and innovation," according to the conclusions.

This comes as the European Commission proposed a broad overhaul of the EU carbon market on July 17, including changes to the rate at which the overall emissions cap is reduced each year, reforms to the MSR, an expansion of coverage in existing sectors, and the inclusion of new industries within the system.

EU Allowance prices have been volatile this year, ranging from €60/metric tons of carbon dioxide equivalent to €90/mtCO₂e, amid political pressure on the carbon market and higher energy prices driven by the war in the Middle East. Platts, part of S&P Global Energy, assessed EU Allowances for December 2026 at €86.12/mtCO₂e Oct. 15.

MSR debate

EU member states agreed on Sept. 23 to double the threshold at which allowances are automatically cancelled, from 400 million to 800 million, effective Jan. 1, 2031, while suspending the invalidation mechanism entirely until end-2030.

The European Parliament has taken a different position, backing a lower threshold of 650 million allowances effective Feb. 1, 2027, and rejecting the commission's earlier proposal to scrap automatic cancellation altogether.

The Council is hoping to conclude negotiations with the Parliament on the MSR file by end-2026.

The MSR was introduced in 2019 to address a persistent oversupply of allowances in the EU carbon market that had suppressed prices and undermined the system's ability to incentivize decarbonization investment.

The MSR works by automatically adjusting the volume of allowances in circulation based on the total number held in the market. Reforms to its intake and cancellation rates have been a recurring source of debate among member states and the European Parliament.

ETS2 assessment

The European Council also directed the commission to update its assessment of all impacts of ETS2, with a particular focus on its design and safeguards.

This signals continued unease among member states about the potential burden of ETS2 on households and small businesses from rising fuel and gas costs, an issue that has dogged the scheme since its adoption.

ETS2 extends carbon pricing to road transport, buildings and small businesses outside the existing EU ETS, directly affecting households through higher fuel and heating costs. The market targets a 42% reduction in emissions from 2005 levels by 2030, with allowance supply expected to tighten in the years following launch.

The launch of ETS2 was delayed from 2027 to 2028 to provide additional time for affected sectors and member states. The postponement also occurred amid lingering concerns that ETS2 could lead to substantial increases in energy prices, highlighting the complex interplay between ambitious climate objectives and economic realities.

So far, only 13 of the 27 member states have enacted the necessary rules in their national law. This also comes as early ETS2 allowance auctions are set to begin in 2027, a year before the market's formal start, with the aim of providing liquidity and enabling long-term hedging.

ETS2 will run in parallel to the existing EU ETS, and the supply of allowances is expected to tighten in the year or two after launch. ETS2 targets a 42% reduction in emissions by 2030 from 2005 levels.