EU carbon market to be recalibrated

The EU is preparing a new round of targeted adjustments to its flagship carbon pricing instrument, the EU Emissions Trading System (EU ETS), as reflected in a Commission initiative published in April 2026 and analyzed in recent European Parliamentary Research Service materials. Rather than introducing a fundamentally new system, the forthcoming revision is framed as a recalibration of existing ETS architecture in light of the EU’s strengthened 2040 climate target and the continued implementation of the “Fit for 55” legislative package.

A central focus of the review is the long-term trajectory of the ETS cap. The linear reduction factor (LRF), which determines the annual rate of decline in total available allowances, is expected to be reassessed to ensure consistency with the EU’s post-2030 emissions pathway under the European Climate Law. Closely linked to this is the reform of the Market Stability Reserve (MSR), which plays a key role in balancing supply and demand of allowances and mitigating structural oversupply. The April 2026 initiative highlights possible adjustments to MSR parameters, including intake rates and the treatment of surplus allowances held in the reserve, potentially strengthening the mechanism’s ability to absorb shocks and reduce long-term volatility in carbon prices. The scope and architecture of the ETS are also under review. The initiative considers further refinements to emissions accounting rules, including more explicit integration of carbon removals through carbon capture, utilization and storage (CCUS). While broader sectoral expansion remains part of the policy discussion, particularly in relation to maritime emissions and smaller installations, any extension is expected to remain gradual and carefully phased rather than constituting a systemic overhaul.

Another key element is the evolution of free allocation rules. The Commission continues its gradual approach to reducing free allocation for sectors exposed to carbon leakage, while maintaining transitional protection for energy-intensive industries. The review focuses on updating benchmark values to reflect technological progress and decarbonization trends, in parallel with the phased introduction of the Carbon Border Adjustment Mechanism (CBAM), which is intended to address competitiveness concerns through border-based carbon pricing adjustments. The use of ETS auction revenues is also gaining prominence, with discussions centered on enhancing revenue recycling into decarbonization investments, including targeted support for lower-income Member States and industrial transition projects.

At the same time, the reform debate is shaped by diverging Member State positions on carbon price volatility and its transmission into electricity prices. While some governments advocate for smoother price dynamics or transitional flexibility, others emphasize the need to preserve a strong and predictable carbon price signal as the central driver of low-carbon investment. This tension continues to influence the balance between market stability and price responsiveness within the ETS design. The ETS review is closely connected to the EU electricity market reform adopted in 2024, which aimed to reduce the direct pass-through of fossil fuel price volatility into electricity prices. Although that reform introduced important structural changes, ongoing market fluctuations have kept electricity market governance on the EU’s legislative agenda, with the current approach favoring incremental adjustments rather than a full redesign.

Overall, the April 2026 Commission initiative signals a shift in EU carbon market governance towards incremental optimization rather than structural expansion. The EU ETS remains the cornerstone of EU climate policy, but its design is increasingly subject to iterative refinement, particularly regarding the cap trajectory, stability mechanisms, sectoral coverage, and its interaction with complementary instruments such as CBAM and electricity market regulation.