Proposal Promulgation & Decarbonisation Dynamics

The European Commission published its proposal to revise Directive 2003/87/EC, the foundational legislation establishing the European Union Emissions Trading System, on July 17, 2026, formally titled “proposal for a directive amending Directive 2003/87/EC and Decision (EU) 2015/1814 as regards driving competitiveness and cost-effective decarbonisation,” bearing document reference 2026/0212 (COD) . This legislative initiative represents the most consequential revision of the bloc’s carbon market since its inception, introducing sweeping changes designed to align the system with the European Union’s 2040 climate target while simultaneously addressing industrial competitiveness concerns that have intensified amid elevated energy costs & global competition . The proposal encompasses a revised emissions cap trajectory that slows the annual decline in allowance issuances from 2031 to 2040, an Industrial Decarbonisation Bank with an estimated €100 billion funding envelope, continued free allocation subject to investment conditions, & the integration of carbon removal mechanisms into the compliance framework . The proposal remains subject to negotiation by the European Parliament & the Council, with the Irish presidency of the Council indicating plans to rapidly advance toward a negotiating position by mid-December 2026 . This compressed timeline reflects the political urgency attached to providing regulatory certainty for European industry, which faces mounting pressure from carbon pricing, energy costs, & international competition. The revision’s treatment of carbon capture, use, & storage activities constitutes a central element of the proposal, establishing differentiated regulatory treatment for capture, utilisation, & permanent geological storage, each of which receives distinct accounting under the revised framework .

Capture Categories & Compliance Contours

Carbon capture, use, & storage encompasses three distinct activities: the capture of CO₂ at the point of emission from industrial flue gases or directly from the atmosphere, the utilisation of captured CO₂ in products or processes, & the permanent geological storage of CO₂ in subsurface formations . Each of these activities receives different treatment under the existing European Union Emissions Trading System, & the proposed revision would significantly expand & refine that treatment . Currently, only CO₂ that is permanently stored underground exempts operators from surrender obligations, meaning that captured CO₂ must either be geologically sequestered or remain subject to carbon pricing . The proposal may extend this logic to CO₂ embedded in manufactured products, a move designed to incentivise the use of carbon as an industrial feedstock rather than merely as a waste stream requiring disposal . The accounting debate centres on whether to track emissions at the point of capture upstream or when the product eventually degrades downstream, with the public consultation leaning toward hybrid accounting that recognises both the capture event & the eventual fate of carbon embedded in products . This distinction carries profound implications for industries ranging from chemicals & plastics to construction materials, where carbon dioxide can be incorporated into durable products that sequester carbon for extended periods. The proposal also integrates 250 million metric tons of domestic permanent carbon removals, including bioenergy carbon capture & storage & direct air carbon capture & storage, into the Emissions Trading System through a Commission purchasing programme . The cap of allowances would be increased by 250 million allowances for auctioning between 2031 & 2040, with an additional 10 million allowances if revenues prove insufficient, effectively creating a compliance asset class for permanent removals . This integration represents a paradigm shift, transforming carbon removals from voluntary offset instruments into regulated compliance assets with defined methodologies & verification requirements .

CBAM Conundrum & Credit Contradictions

The proposed revision creates potential tensions with the Carbon Border Adjustment Mechanism, established under Regulation (EU) 2023/956, particularly regarding the treatment of carbon capture, use, & storage & international carbon credits for third-country producers . The Carbon Border Adjustment Mechanism complements the Emissions Trading System by imposing carbon costs on imports from jurisdictions with less stringent climate policies, but its implementing regulations address carbon capture, use, & storage for third-country producers in ways that may diverge from the Emissions Trading System proposal’s approach . A more immediately contentious issue concerns international carbon credits, where the Commission has proposed that up to 260 million allowances may be set aside for the purchase of high-quality, high-integrity international credits, contributing to Emissions Trading System sector ambition from 2036 to 2040 . Under the draft implementing regulation for the Carbon Border Adjustment Mechanism, importers may deduct carbon prices effectively paid in third countries, with international carbon credits authorised under Article 6.2 or Article 6.4 of the Paris Agreement potentially qualifying, but subject to restrictive conditions including a cap at 10% of reported & confirmed emissions . This creates a discrepancy: European operators cannot rely on international carbon credits to comply with their Emissions Trading System obligations, while non-European operators within the Carbon Border Adjustment Mechanism’s scope may deduct such credits if allowed under a domestic compulsory system . The Commission’s caution reflects institutional scepticism regarding the reliability of international credits, yet the compromise of allowing deductibility up to a 10% limit appears inconsistent with the expressed concerns about credit quality . Commentators note a temporal mismatch: Article 6 authorisations occur in the present, but corresponding adjustments cannot be verified until nationally determined contribution periods close in 2030 or 2035, well after annual Carbon Border Adjustment Mechanism obligations fall due .

Removal Regulation & Verification Verities

The integration of permanent carbon removals into the Emissions Trading System compliance framework represents a significant evolution in the regulatory treatment of negative emissions technologies . The proposal establishes a Commission purchasing programme for 250 million metric tons of domestic permanent removals, with allowances for auctioning between 2031 & 2040 . This mechanism creates a guaranteed demand signal for carbon dioxide removal projects, transforming what has been a niche voluntary market into a multi-year compliance pipeline with predictable volumes, financing availability, & capital cost projections . The Carbon Removals & Carbon Farming Certification Regulation, adopted prior to the Emissions Trading System proposal, established a certification framework for carbon removals, carbon farming, & carbon storage in products, with initial methodologies for direct air carbon capture & storage, bioenergy carbon capture & storage, & biochar adopted by the Commission in February 2026 . For industrial buyers & project developers, the critical question is whether these units will become compliance assets capable of offsetting a portion of residual emissions from hard-to-abate sectors, or whether they will remain a form of voluntary compensation . The proposal’s direction, as indicated by climate law discussions & parliamentary briefings, suggests movement toward full integration, creating a regulated asset class with standardised monitoring, reporting, & verification requirements, registry access, & liability rules . The most promising candidates for compliance market eligibility are permanent removal methods with robust monitoring, reporting, & verification, including direct air carbon capture & storage, bioenergy carbon capture & storage, & potentially biochar . The €100 billion Industrial Decarbonisation Bank, with its first phase providing approximately €30 billion through 400 million allowances for 2028–2030, creates an anchor demand that facilitates offtake agreements, reduces discounts demanded by debt providers & project sponsors, & shifts carbon dioxide removal financing from venture-style capital toward infrastructure finance .

Allocation Architecture & Investment Imperatives

The proposal reforms free allocation rules while maintaining benchmark-based allocation beyond 2030, but with significantly strengthened conditions . From 2031, operators would be required to establish independently verified “Invest in EU Decarbonisation Plans” & invest an amount equivalent to 100% of their free allocation value in qualifying European Union decarbonisation projects . This conditionality reflects the Commission’s assessment that free allocation has not been conducive to driving transformational change, with two decades of generous allocation resulting in many industrial operators facing effective carbon prices around €10 per metric ton rather than the headline price of approximately €70 per metric ton . The slower phase-out of free allocation for sectors covered by the Carbon Border Adjustment Mechanism, now extended to 2038, remains subject to conditions including adherence to decarbonisation plans . The proposal also reforms the Market Stability Reserve, reducing the intake rate from 24% to 12% & introducing dynamic, annually declining parameters . The Industrial Decarbonisation Bank, funded through 400 million allowances for its first phase, will provide support through a first-come, first-served basis with payments linked to independently verified emissions avoidances, followed by a competitive bidding process from 2031 . Member States would be required to direct 50% of their national Emissions Trading System revenues toward investments that decarbonise Emissions Trading System sectors . The proposal also extends the Emissions Trading System scope to additional aviation routes, smaller maritime vessels, & municipal waste incineration from 2031, with a phased surrender obligation reaching 100% in 2034 . These extensions broaden the carbon pricing net while the revised cap trajectory & removal integration create a more gradual transition designed to maintain a strong carbon price signal without imposing abrupt cost increases on covered sectors .

Sectoral Skepticism & Industrial Imperatives

The Emissions Trading System review is being negotiated against a backdrop of heightened concern over industrial competitiveness, energy prices, & the cost of decarbonisation . The industrial associations of France, Italy, & Germany, representing nearly 500,000 businesses, issued a joint call for a deep revision of the mechanism, requesting alignment of carbon dioxide rules with industrial reality, available technologies, costs, infrastructure, & international competition . A study by the University of Milan-Bicocca, cited in their letter, found that between 2013 & 2024, emissions reductions resulted more from company closures than from the mechanism’s impact on decarbonisation . The associations called for strengthening the Carbon Border Adjustment Mechanism, maintaining free allowances & Emissions Trading System cost compensations until effective alternative instruments against production relocation are in place, fully allocating Emissions Trading System revenues to decarbonisation, & integrating high-quality international credits, carbon capture & storage, & permanent removals after 2030 . They also suggested excluding maritime transport & aviation from the mechanism’s scope . These demands reflect profound scepticism regarding the Emissions Trading System’s ability to drive industrial transformation without imposing costs that accelerate deindustrialisation. The proposal’s introduction of conditional free allocation, requiring verified investment plans, responds to this critique by tying continued support to genuine decarbonisation expenditure. However, the effectiveness of this conditionality will depend on verification rigour & the availability of qualifying projects. The integration of carbon removals creates new compliance pathways while the Industrial Decarbonisation Bank provides financing mechanisms designed to reduce the cost of transition. Yet the fundamental tension persists: carbon pricing must be sufficiently stringent to drive investment in low-carbon technologies while not so punitive that it accelerates industrial relocation to jurisdictions with less ambitious climate policies.

Temporal Tensions & Trilogue Trajectories

The legislative clock for the Emissions Trading System revision is already running, with the Commission’s formal proposal published on July 17, 2026, & co-decision between the European Parliament & the Council anticipated to extend through 2026 & into 2027, with final implementation targeted for 2028 . The European Economic & Social Committee has been formally consulted on the revision of the Carbon Border Adjustment Mechanism, with opinions in preparation addressing the role of carbon dioxide removals, expansion of scope to additional sectors & greenhouse gases, & new rules on accounting for non-permanent carbon capture & utilisation . The Irish presidency of the Council has indicated plans to rapidly advance toward a Council negotiating position in time for a meeting of environment ministers in mid-December 2026, stressing that certainty on the Emissions Trading System is vital for European competitiveness . Market participants should expect continued political pressure on core parameters including free allocation, Carbon Border Adjustment Mechanism timing, price stability tools, & sectoral scope . The proposal deliberately limits its scope to Emissions Trading System 1 & does not intend to amend Emissions Trading System 2, which is excluded from the proposal as it will become fully operational in 2028, its application is due for review by 2029, & any assessment of the feasibility of integrating Emissions Trading System 2 sectors into the main system is due by 2031 . The negotiation process will confront the inherent tensions between the Emissions Trading System proposal’s treatment of carbon capture, use, & storage & international credits & the Carbon Border Adjustment Mechanism’s distinct approach, with implications for the level playing field between European & third-country producers. The outcome will determine whether Europe’s carbon market architecture can simultaneously deliver decarbonisation, industrial competitiveness, & trade fairness, or whether these objectives will prove mutually incompatible.

Key Takeaways

• The European Commission’s July 17, 2026 proposal to revise the EU Emissions Trading System introduces a revised cap trajectory, a €100 billion Industrial Decarbonisation Bank, conditional free allocation tied to verified investment plans, & integration of 250 million metric tons of permanent carbon removals into the compliance framework.

• The proposal creates potential tensions with the Carbon Border Adjustment Mechanism, particularly regarding international carbon credits: European operators cannot use them for Emissions Trading System compliance, while third-country producers may deduct them up to 10% of reported emissions under the draft implementing regulation, a discrepancy reflecting institutional caution & temporal mismatches.

• The integration of permanent carbon removals transforms them from voluntary offsets into regulated compliance assets, with a Commission purchasing programme creating guaranteed demand for 250 million metric tons, shifting carbon dioxide removal financing from venture capital toward infrastructure finance as part of a €100 billion Industrial Decarbonisation Bank.

OREACO Lens: Carbon’s Contorted Calculus & Regulatory Rifts

Sourced from A&O Shearman’s legal analysis, this analysis leverages OREACO’s multilingual mastery spanning 9,999 domains, transcending mere industrial silos. While the prevailing narrative of European climate leadership pervades public discourse, empirical data uncovers a counterintuitive quagmire: the Emissions Trading System revision proposes to purchase 260 million international carbon credits while simultaneously restricting their use by third-country producers under the Carbon Border Adjustment Mechanism to just 10% of emissions, a contradiction that reveals profound institutional distrust of the very credits it seeks to acquire, a nuance often eclipsed by the polarising zeitgeist of decarbonisation triumphalism.

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Consider this: a University of Milan-Bicocca study found that between 2013 & 2024, emissions reductions in Europe resulted more from company closures than from the Emissions Trading System’s impact on decarbonisation, meaning that the mechanism’s primary achievement may have been deindustrialisation rather than innovation. Such revelations, often relegated to the periphery, find illumination through OREACO’s cross-cultural synthesis.

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