The European Union has unveiled sweeping reforms to its flagship carbon market that would ease compliance requirements for manufacturers, extend free emissions allowances for heavy industry and channel up to €100 billion into clean industrial investment, marking one of the most significant recalibrations of the EU Emissions Trading System (ETS) since its launch two decades ago. The proposals, announced by the European Commission, seek to balance Europe’s long-term climate ambitions with mounting concerns over industrial competitiveness, investment leakage and rising energy costs, offering lessons that could influence carbon market development and industrial decarbonisation strategies across Africa.
If adopted, the reforms would slow the pace at which carbon allowances decline, extend free emissions permits for sectors including steel and cement until 2038 and redirect a larger share of carbon market revenues towards electrification, hydrogen production, carbon capture technologies and low-emissions manufacturing. The European Commission argues that the revised framework remains consistent with the bloc’s legally binding objective of reducing net greenhouse gas emissions by 90% by 2040 while providing industries with greater flexibility to manage the transition towards climate neutrality.
The proposals emerge as European policymakers face growing pressure from manufacturers warning that high carbon prices, elevated energy costs and increasing international competition risk undermining Europe’s industrial base. Since the introduction of the European Green Deal, policymakers have sought to accelerate decarbonisation while maintaining the competitiveness of energy-intensive industries that remain central to employment, exports and economic growth.
The EU Emissions Trading System currently covers sectors responsible for approximately 40% of the European Union’s greenhouse gas emissions, including electricity generation, manufacturing, aviation and maritime transport. Established in 2005, the ETS remains the world’s largest carbon market and has become a global benchmark for emissions trading schemes now being developed in countries including China, the United Kingdom, South Korea and several emerging economies.
Under the existing system, companies must surrender one carbon allowance for every metric tonne of carbon dioxide they emit. The European Union limits the total number of allowances available, gradually reducing supply each year to increase the cost of pollution and encourage investment in cleaner technologies. Carbon prices within the ETS have become an increasingly influential signal for industrial investment decisions, renewable energy deployment and corporate decarbonisation strategies.
The European Commission’s latest proposal would moderate that tightening trajectory. Instead of maintaining the current annual reduction rate of 4.3%, the emissions cap would decline by 3.7% annually from 2031 before slowing further to 1.7% from 2036. The Commission also proposes reducing the intervention rate of the Market Stability Reserve—the mechanism designed to manage allowance supply and stabilise carbon prices—from 24% to 12%, effectively leaving more allowances available within the market.
According to the Commission, introducing greater flexibility aims to reduce compliance pressures while preserving the long-term integrity of the carbon market. However, environmental economists note that expanding allowance availability could moderate carbon prices, potentially reducing short-term incentives for emissions reductions while providing greater certainty for industrial investment planning.
The reforms also introduce a new mechanism permitting international carbon credits to contribute towards emissions reductions from 2036 onwards. These credits could account for up to 2% of emissions reductions required under the ETS, providing companies with additional compliance options while strengthening international carbon market linkages.
The proposed changes extend beyond carbon pricing to industrial policy. The Commission recommends prolonging free emissions allowances for sectors covered by the Carbon Border Adjustment Mechanism (CBAM), including steel, cement and other emissions-intensive industries, until 2038 rather than phasing them out by 2034 as originally planned.
Under the revised framework, companies would initially receive 80% of their free allowances upon submitting credible European decarbonisation investment plans. The remaining 20% would only be allocated after those investments are completed, strengthening the connection between public climate support and measurable industrial transformation. The 10% most efficient industrial facilities would remain exempt from these additional conditions, recognising existing leadership in emissions performance.
The Commission also proposes slowing the tightening of industrial emissions benchmarks used to calculate free allocations. From 2030, benchmark reduction rates would decrease from the current 2.5% annually to 2%, while an additional adjustment covering the period between 2026 and 2030 could provide industry with approximately €6 billion in additional free allowances.
According to the European Commission, these measures are intended to reduce the risk of carbon leakage, whereby companies relocate production to jurisdictions with less stringent climate regulations. Carbon leakage has become a growing concern as industries compete globally against manufacturers operating in regions with lower energy prices and fewer carbon constraints.
The financial implications of the proposed reforms are equally significant. Since 2013, the EU Emissions Trading System has generated approximately €260 billion in revenues, with nearly 80% flowing directly into national government budgets. Under the revised proposal, member states would be required to allocate at least half of future ETS revenues towards supporting domestic industrial decarbonisation, potentially reducing fiscal flexibility for national governments while accelerating investment in clean manufacturing.
Brussels also proposes establishing a dedicated industrial investment facility supported by 400 million carbon allowances valued at approximately €30 billion through 2030. From 2031 onwards, companies would be eligible to compete for a further €70 billion in carbon allowances supporting projects including industrial electrification, hydrogen deployment, carbon capture and storage (CCS), carbon capture utilisation (CCU) and low-emissions manufacturing technologies.
The Modernisation Fund, which supports lower-income European Union member states in financing clean energy investments, would continue beyond 2030 with an allocation of 280 million carbon allowances, reinforcing efforts to ensure that the energy transition remains equitable across the bloc. Beyond heavy industry, the proposed reforms would significantly expand ETS coverage across aviation, maritime transport and waste management. Aviation emissions obligations would extend to flights departing Europe for destinations within a 5,000-kilometre radius, bringing routes to cities such as Dubai and Istanbul within the carbon market while excluding most long-haul flights to destinations including China and the United States.
Shipping regulations would also broaden considerably. The emissions trading system would apply to vessels as small as 400 gross tonnes, compared with the current threshold of 5,000 tonnes. Maritime operators would receive approximately 110 million free allowances to facilitate investment in cleaner fuels, energy-efficient vessels and emissions reduction technologies. Waste incineration facilities would gradually enter the ETS between 2031 and 2034, although member states would retain the option to delay implementation until 2035 under specific taxation or recycling conditions.
The legislative package now enters negotiations between the European Parliament and EU member states, where amendments are expected before final legislation is adopted. The process is likely to extend for at least a year, reflecting the complexity of balancing climate ambition, industrial competitiveness and fiscal priorities across 27 member states. While the reforms are designed for Europe, their implications extend far beyond the continent. The European Union remains one of Africa’s largest trading partners and a leading source of climate finance, development assistance and industrial investment. Changes to European carbon pricing, industrial support mechanisms and the implementation timeline of the Carbon Border Adjustment Mechanism will directly influence African exporters of steel, cement, aluminium, fertilisers and other carbon-intensive goods seeking continued access to European markets.
According to the African Development Bank (AfDB), African economies will require substantial investment in industrial decarbonisation to remain competitive as global carbon pricing mechanisms expand. Countries with abundant renewable energy resources, including Kenya, Namibia, Morocco, South Africa and Egypt, are increasingly positioning themselves as future suppliers of green hydrogen, low-carbon manufactured products and renewable-powered industrial exports.
The proposed reforms also illustrate an evolving global approach to climate policy. Rather than relying solely on emissions regulation, governments are increasingly integrating industrial strategy, public investment and climate finance to accelerate the transition towards low-carbon economies while protecting economic competitiveness.
For Africa, where several countries are exploring domestic carbon markets under Article 6 of the Paris Agreement, Europe’s experience demonstrates the importance of designing climate policies that simultaneously reduce emissions, attract investment and support industrial development. As global carbon markets mature and climate-related trade measures expand, the interaction between environmental regulation and economic competitiveness is likely to become an increasingly important consideration for policymakers across both developed and emerging economies.
