The European Union is considering a change to the Emissions Trading System (ETS) that would extend the period during which European manufacturers receive free carbon allowances. The proposal comes as importers enter the first year of binding Carbon Border Adjustment Mechanism (CBAM) obligations. The interaction between the two instruments is central to EU industrial and climate policy.
The European Commission’s changes would prolong free allocation coverage for sectors included in CBAM. Under the current approach, free allowances for those sectors are scheduled to decline and reach zero in 2034. The Commission’s July 2026 ETS revision proposal would move that endpoint to 2038, slowing the withdrawal of allocations.
ETS and CBAM timelines linked through transition adjustments
The ETS sets a carbon price for emissions from installations located within the EU. CBAM applies a corresponding carbon cost to selected imported products. During the transition period, adjustments to CBAM certificate obligations are designed to reflect the free allowances still available to European producers.
This structure is intended to prevent imported products, including steel and cement, from bearing the full carbon charge while EU manufacturers continue receiving benchmark-based free allocations. At the same time, the framework does not produce identical carbon costs across all industrial installations. Operational efficiency, product composition, emissions accounting boundaries, and national support schemes influence how much carbon exposure each facility faces in practice.
Under the Commission’s proposed timetable, European industrial installations would keep free allocations for longer than previously planned. Brussels argues that manufacturers need additional time and investment support to complete decarbonisation projects while maintaining their position against international competitors. For importers, a slower phase-out could moderate how quickly CBAM exposure increases over coming years.
For producers outside the EU, the revised schedule would shift when competitive effects tied to product carbon intensity emerge. The proposed extension remains subject to the EU legislative process and is not an adopted exemption from existing obligations. Importers therefore face ongoing uncertainty about how ETS-linked changes will affect CBAM-related costs over time.
Sector-specific decarbonisation costs shape competitive conditions
The industrial implications vary across sectors covered by carbon pricing and border adjustment rules. Integrated steelworks would need substantial capital expenditure to replace or modify existing production technologies. Cement producers face emissions reductions linked both to fuel combustion and limestone processing.
Aluminium smelters must manage electricity procurement costs alongside improvements in production efficiency. A carbon price can support investment in lower-emission production, but it can also pressure industrial margins where financing access, suitable technologies, and supporting infrastructure are limited. The Commission’s approach aims to address this tension using ETS revenues and investment-linked allocation mechanisms.
Access to support differs between EU installations and producers located outside the EU. This creates different conditions for companies competing in the same markets even when they operate under comparable product categories. The policy challenge described in the proposal is maintaining incentives for emissions reductions without accelerating relocation of industrial investment to jurisdictions with less stringent carbon constraints.
CBAM compliance depends on regulatory, technical and financial inputs
Companies importing covered products must manage CBAM exposure through three distinct areas: regulatory eligibility, emissions performance, and financial settlement. Regulatory assessment starts with correct customs classification, confirmation of the declarant’s authorisation status, and verification that the imported product falls within CBAM’s scope.
The technical assessment focuses on emissions generated at the producing installation, relevant upstream inputs, and whether verified actual emissions data are available. Replacing default values with reliable installation-specific information can affect how much carbon exposure an imported product carries under CBAM rules.
The financial assessment covers official CBAM certificate reference prices. It also includes deductions for eligible carbon payments made in the country of production, certificate purchasing dates, and how costs are allocated through commercial contracts between contracting parties. These elements can generate different compliance risks within a single business.
A company may complete regulatory preparations but lack reliable emissions data. Alternatively, it may have verified production information while facing uncertainty about how carbon costs are treated contractually. Separating these assessments helps identify whether exposure primarily stems from regulatory requirements, reporting shortcomings at factory level, or missing commercial arrangements.
Longer free allocation phase-out affects supply contracts
The proposed extension of the free allowance phase-out has implications for trade agreements and industrial procurement arrangements. Importers and suppliers need clarity on which contractual party bears financial consequences of carbon pricing. They also need to determine who is responsible for providing embedded-emissions information and how additional costs will be allocated if regulations change after a shipment price has been agreed.
Contracts based on a fixed assumed CBAM charge can become exposed if ETS carbon prices change or if adjustments occur to the free allocation timetable. This can create uncertainty for both buyers and sellers, particularly when agreements cover deliveries over extended periods rather than single shipments.
The source describes scenario-based pricing as a framework for managing these risks compared with relying on a single forecasted carbon cost. Supply agreement terms increasingly need to account for changes in carbon pricing, emissions verification requirements, and timing of regulatory adjustments related to ETS and CBAM implementation.
Western Balkans electricity exports face different CBAM treatment
The Western Balkans face specific CBAM-related challenges involving electricity deliveries. Electricity may be subject to a substantially sharper carbon adjustment than industrial products that benefit from transitional benchmark relief under CBAM rules described in this context.
Domestic carbon taxes may reduce amounts payable under CBAM where eligible payments meet requirements and can be properly documented. Establishing origin and emissions characteristics of electricity deliveries is also described as critical for compliance outcomes under CBAM.
A renewable electricity producer able to provide credible evidence of generation may have a different compliance position than a power trader that cannot demonstrate origin of electricity included in a scheduled delivery. As a result, commercial implications for exporters extend beyond regulation alone.
Technical reporting, generation documentation, and physical arrangements governing cross-border electricity deliveries influence how exports are treated under CBAM requirements. These requirements can create different exposure levels for renewable generators, electricity traders, and industrial exporters operating within the region.
Legislative process leaves companies managing two regulatory timelines
The Commission’s proposed move toward an endpoint in 2038 adds another variable into how Europe’s carbon pricing system interacts with its border adjustment mechanism. Policymakers must determine whether extending free allocations preserves industrial competitiveness while providing sufficient investment time without weakening incentives to reduce emissions.
For manufacturers, importers, and international suppliers, distinguishing between obligations already applicable in 2026 and potential legislative changes affecting later years remains essential for planning compliance activities. The existing ETS and CBAM framework continues to provide the basis for current compliance requirements while any revisions remain subject to legislative procedures.
Bearing binding obligations alongside uncertainty about how quickly free allocation withdrawal will progress is therefore part of operational planning for cross-border industrial trade under these instruments. The proposed extension does not remove existing obligations during this period of legislative review.