From pricing carbon to boosting investment: why the EU ETS reform matters
With auction revenues of more than 600 billion euro at stake over the next decade, Europe's carbon market reform is also a decision about financing Europe’s industrial transformation. Getting the design right is essential to finance a modern, resilient European industrial base.
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Julian Parodi
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Benjamin Görlach
The much-debated revision of the EU Emissions Trading System (ETS) will determine how much new funding flows into Europe’s industrial transformation – from electrification, grids and storage expansion to hydrogen and carbon capture. Used well, these resources can help European industry accelerate its path towards resilience and competitive sustainability.
The choices made in the ETS review will determine three outcomes: how many allowances are auctioned, at what price they are sold, and where the revenues go. This will shape how much money is available to modernise factories, deploy clean technologies and cut emissions at scale.
As Members of the European Parliament and EU governments hone their positions on the reform, we have calculated what is at stake for financing the industrial transformation – and propose how to secure an outcome that uses scarce revenues efficiently.
Fewer allowances, rising prices: a 600-billion-euro opportunity
According to the European Commission proposal from July, the EU would issue around 5.4 billion allowances in phase V (2031 to 2040), less than half of the 12.6 billion in the current phase (2021 to 2030). Of these, about 4.2 to 4.4 billion would be auctioned, while between 1 and 1.2 billion will be allocated to industry for free. Yet, despite fewer allowances overall, total revenues could rise: analysts expect the carbon price to climb from around 88 euro today to an average of around 150 euro per tonne over 2031–2040. At that price, total auction revenues could reach more than 600 billion euro.
Where the revenues go
Of the more than four billion allowances auctioned in the next phase, 1.7 billion are already earmarked for specific purposes:
- The revenues of 250 million allowances go to the Innovation Fund.
- The revenues of 400 million allowances are earmarked for the new Industrial Decarbonisation Bank.
- The revenues of around 400 million allowances benefit the Modernisation Fund, including 102 million from its dedicated endowment and an estimated 296 million from Member States’ solidarity allocations.
- The revenues of an additional 250 million allowances issued outside the ETS cap go to financing permanent carbon dioxide removals, together with a 10 million top-up from within the cap.
- The revenues of up to 260 million allowances finance the procurement of international carbon credits.
- The revenues of 110 million allowances support sustainable alternative propulsion technologies in maritime transport.
- The revenues of 0.9 million allowances go to maritime support for developing countries, and 5.5 million allowances cover for ETS administration.
As our diagram shows, after accounting for the Modernisation Fund, maritime support, and other allocations, approximately 2.8 billion allowances would be auctioned by Member States to generate revenues. Under the Commission's proposal, however, not all of this revenue would end up in Member States’ budgets: 30 per cent would go directly to the EU budget as a new "own resource".
In euro terms, Member States could receive up to 300 billion euro over the decade. Under the Commission’s proposal, at least half of these revenues should support decarbonisation investments in ETS sectors. Meanwhile, an additional 150 billion euro would be mobilised through EU-level funding instruments: around 60 billion for the Industrial Decarbonisation Bank, more than 50 billion for the Modernisation Fund, and close to 40 billion for the Innovation Fund. In addition, the Investment Booster (the first phase of the Industrial Decarbonisation Bank) could raise another 30 billion euro by mobilising reserves accumulated before 2030.
If deployed efficiently, this money can leverage additional private capital by de-risking decarbonisation investments and thereby help to close the investment gap for industrial transformation – but only if the ETS review manages to secure sufficient quantities, and a high enough price.
Supporting carbon removals while safeguarding transformation funding
Uncertainty stems from the proposed procurement of permanent carbon removals and its funding. The Commission proposes auctioning 250 million allowances on top of the cap to fund the permanent storage of 250 million tonnes of CO₂ between 2031 and 2040.
But this comes with a complex trade-off: removals are considerably more expensive than the carbon price – and are likely to remain so. At estimated costs of 250 to 300 euro per tonne, financing 250 million tonnes would require roughly 420 to 500 million allowances' worth of revenue – far more than the 250 million initially set aside (see Abegg et al., 2024; Ramboll, 2025). After accounting for an extra 10 million allowances from within the existing cap, a gap of 160 to 240 million allowances persists.
The draft reports from the European Parliament’s environment and industry committees suggest filling this gap from Member States' auction shares. That could consume 8 to 12 percent of national revenues – money that would then no longer be available to support the industrial transformation.
A more modest removal amount would significantly reduce pressure on national budgets while still sending the demand signal needed to scale up the market for permanent carbon dioxide removal.
Allowance supply sets the basis for revenues
The supply of allowances is a key driver of the carbon price, while the share allocated for free or auctioned determines the revenue that can be mobilised for industrial investment. Three design elements are particularly relevant for revenues:
- The linear reduction factor (LRF) sets the pace at which the overall cap declines. A less ambitious trajectory would leave more allowances in the market. This keeps prices below the level they would otherwise reach and reduces the revenues available for investment.
- The Market Stability Reserve (MSR) currently holds 400 million allowances – its maximum capacity – and is expected to begin releasing them in the 2030s. The scale and timing of these releases will matter: larger releases could dampen the price signal and, with it, the revenues generated.
- The phase-out of free allocation for sectors covered by the Carbon Border Adjustment Mechanism (CBAM) could bring an estimated 850 million allowances to auction. Delaying the CBAM phase-in reduces both auction volumes and CBAM revenues – reducing the resources available for transformation.
None of these choices can be made in isolation. More allowances do not automatically mean more revenue: if supply exceeds demand, prices remain low and so do revenues. Getting the balance right between ambition and market stability is therefore key to securing the resources Europe needs for its industrial transformation.
What the ETS reform must get right
The EU ETS could generate more than half a trillion euros over the next decade, which would go a long way towards closing the investment gap in the ETS sectors. How much of this materialises, and whether these resources can accelerate industrial transformation, depends on the decisions taken in the forthcoming review negotiations.
To use this opportunity, maintaining the linear reduction factor of 4.4 percent until at least 2035 and continuing the phase-out of free allocation for CBAM sectors sets a clear and predictable framework conditions, incentivises decarbonisation investments, and delivers sufficient revenues to support such investment. Reducing the carbon dioxide removal procurement target would eliminate a significant source of uncertainty. Overall, these measures would help secure up to 300 billion euro for Member States to spend over the next decade. Finally, all Member State auction revenues should be dedicated to decarbonisation, backed by stronger transparency requirements and faster disbursement.
Diluting the ETS would erode a key source of funding for Europe's industrial transformation. The carbon market already puts a price on carbon. Its next phase must ensure that this price is complemented by investments in clean, cheap and domestically produced energy and low-carbon industrial processes. This will make European industry less dependent on imported fossil fuels and more resilient to volatile global energy markets. It will also modernise Europe’s industrial asset base and help EU industry compete in the post-fossil global economy of tomorrow.
