When emissions become cheaper, the cost to Europe risks rising

Calls to ease pressure on Europe’s carbon market may offer short-term relief, but risk undermining long-term competitiveness and the pace of the energy transition, according to analysis from Vattenfall.

As the EU prepares to review its Emissions Trading System (ETS), debate is intensifying over whether carbon prices should be reduced amid high energy costs and geopolitical uncertainty. However, weakening the system that prices carbon emissions could ultimately make the transition more expensive and less predictable.

The ETS, launched in 2005, requires companies to pay for their carbon dioxide emissions. It has already driven down emissions in covered sectors by around 40% and remains central to the EU’s climate strategy. By setting a declining cap on emissions through the Linear Reduction Factor (LRF), the system ensures that available emission allowances decrease each year, creating a long-term trajectory for decarbonisation.

According to Vattenfall’s Public and Regulatory Affairs Advisor Erik Filipsson, pressure to soften the system is growing as energy prices remain elevated across Europe. He warns that while such measures may appear to reduce costs in the short term, they risk weakening investment signals that are essential for large-scale industrial transformation.

He argues that a strong and stable ETS is not only a climate tool but also a competitiveness instrument, as it directs capital towards low-carbon technologies and reduces reliance on imported fossil fuels, which are a key driver of Europe’s energy price volatility.

Discussions are also ongoing around mechanisms such as the European Commission’s proposed ETS Investment Booster, which would use auction revenues to support industrial decarbonisation and electrification. While supportive of using revenues to accelerate the transition, Vattenfall cautions that altering the supply of allowances in a way that increases short-term liquidity risks undermining price stability in the carbon market.

The Market Stability Reserve, which regulates the supply of allowances to avoid extreme surpluses or shortages, is seen as a key safeguard for maintaining predictable carbon pricing. Any policy that disrupts this balance, critics argue, could weaken confidence in the system and discourage long-term investment.

Differences in national energy mixes are also shaping the debate, with fossil-fuel-dependent economies generally more exposed to high prices than countries with larger shares of low-carbon electricity generation. This divergence is influencing political positions on how strict the post-2030 ETS framework should be.

Supporters of maintaining a strong carbon price emphasise that the gradual tightening of the emissions cap is fundamental to the system’s credibility. Lowering the Linear Reduction Factor, they argue, would risk slowing investment and penalising early movers that have already committed to decarbonisation.

The broader policy challenge for the EU is balancing short-term cost pressures with long-term climate and industrial competitiveness goals. Alongside ETS reform, the introduction of the Carbon Border Adjustment Mechanism is intended to reduce carbon leakage by applying a carbon price to imports from countries with weaker climate policies.

Ultimately, the direction taken in the coming EU negotiations will shape not only emissions outcomes, but also Europe’s energy security, industrial strategy and global economic position.