The EU ETS Is Also a Cornerstone of Europe’s Emerging Industrial Policy

The European Union Emissions Trading System is rightly described as the cornerstone of Europe’s climate architecture. Most policymakers, industrial leaders and climate experts now accept that point. The ETS has helped reduce emissions from the sectors it covers, created a common carbon price and anchored expectations about the direction of European policy. The debate surrounding its forthcoming revision is therefore not about a marginal regulatory instrument. It is about one of the central economic institutions of the European Union.

Yet the ETS should no longer be viewed solely as a climate-mitigation mechanism. It is also becoming one of the cornerstones of Europe’s emerging industrial policy. It performs three functions simultaneously: it limits emissions, provides a price signal for investment and generates a stream of public revenues that can help finance the transformation it requires.

This third function is still too often treated as secondary. It should instead sit at the heart of the current debate. In a context of severe budgetary constraints in many Member States, a politically compressed Multiannual Financial Framework and monumental financing competition with the United States and China, Europe cannot afford to regard carbon revenues as an incidental fiscal dividend. They are one of the few seizable resources generated by a genuinely European policy instrument and capable of supporting a genuinely European industrial strategy.

The central question raised by the ETS review should therefore not be only how quickly the cap declines or when European industry is expected to reach net zero. It should also be: how can Europe use the value created by its carbon market to build the industrial capacity it wants to retain in 2050?

A double industrial lever

The ETS pushes industrial transformation twice. 

First, by increasing the effective cost of carbon-intensive production, it progressively narrows the price gap between conventional and low-carbon technologies. This signal is imperfect and cannot, on its own, overcome every investment barrier. But without a credible carbon price, many low-carbon business models-green steel, clean chemicals, industrial electrification or carbon capture-become even harder to finance.

Second, the auctioning of allowances generates revenues that can be recycled into the transition. Between 2013 and the end of 2025, EU ETS auctions raised more than EUR 258 billion. Annual revenues reached EUR 43.6 billion in 2023, EUR 38.8 billion in 2024 and more than EUR 43 billion in 2025. These are not negligible sums, particularly when national budgets are under pressure and Europe’s common budget is being asked to finance climate, defence, digital infrastructure, enlargement and economic security at the same time.

But Europe is not using this resource in accordance with the scale of its industrial challenge. Of the EUR 16.4 billion in Member-State revenues reported as disbursed under the relevant climate-spending obligation in 2024, only EUR 0.8 billion went directly to industrial decarbonisation. That is less than 5%. By comparison, EUR 3.2 billion of auction revenues were used to compensate electricity-intensive industries for indirect carbon costs. Europe is still spending considerably more of its carbon revenues compensating the costs of the existing economy than building the economy that should replace it.

This is not an argument against compensation where exposure is real. It is an argument about balance and direction. The political durability of the ETS ultimately depends on demonstrating that the revenues raised from industry are used to make industrial transformation possible. The carbon ‘stick’ will remain increasingly difficult to defend if the corresponding ‘carrot’ is too small, too slow or too fragmented.

There is also a specifically European inconsistency. The Union has created a common carbon market, but recycles most of its revenues through national budgets and national priorities. It mutualises the constraint while fragmenting the means of responding to it. That model becomes increasingly dangerous when Member States possess radically different fiscal capacities.

The Single Market cannot be financed through twenty-seven different fiscal capacities

The relaxation of State-aid rules is often presented as Europe’s principal response to the industrial-policy race. It may be necessary, but it is not sufficient. Permission to spend is not the same thing as a common capacity to spend.

The experience of the Temporary Crisis and Transition Framework makes this clear. Between March 2022 and the end of 2025, Germany, Italy and Spain accounted for 68% of all aid granted under the framework and related Treaty measures. Looking only at the provisions supporting renewables, industrial decarbonisation and net-zero manufacturing, Member States granted approximately EUR 19.5 billion, while nine Member States granted no support at all under those provisions. The distribution is not identical across every category, but the conclusion remains: national fiscal space strongly influences where European industrial policy can actually be implemented.

This creates a real risk for the Single Market. Companies face the same European carbon price, but their ability to obtain support increasingly depends on the balance sheet of the Member State in which they happen to operate. Over time, differences in national fiscal capacity can become durable differences in industrial competitiveness and determine the geographical distribution of strategic investments.

The ETS offers an opportunity to escape this debate from above. A greater share of its present and future revenues should finance common European instruments, allocated through EU-wide auctions and based on transparent criteria: avoided emissions, production of low-carbon materials, contribution to resilience and capacity to mobilise private investment. The aim should not be to replace every national policy, but to ensure that a company’s ability to decarbonise does not depend principally on whether it is located in a fiscally powerful Member State.

Conditional free allocation is attractive but cannot replace an OPEX support strategy

One of the most politically attractive ideas in the current debate is to extend or grant free allowances on the condition that companies invest in decarbonisation in Europe. The logic is understandable. If public authorities continue to protect an installation from part of the carbon cost, the company should provide a measurable investment commitment in return.

This principle is not entirely new. Under the current rules, free allocation can already be reduced by 20% when operators fail to implement relevant energy-efficiency recommendations. Installations whose emissions intensity is above the 80th percentile of the applicable product benchmark can also lose 20% of their free allocation unless they submit a compliant climate-neutrality plan. The forthcoming reform may broaden and strengthen this conditionality.

Used carefully, conditional free allocationcan be a legitimate transitional instrument. It can protect strategic capacity, improve cash flow and help a company cross the initial investment threshold. This may be particularly important where the Carbon Border Adjustment Mechanism remains incomplete, where European exports receive no equivalent protection in third markets or where decarbonisation technologies are not yet commercially mature.

But the idea does not answer the OPEX question. Free allowances reduce the carbon-compliance cost of an existing installation. They do not necessarily make the low-carbon output of a new installation competitive. A company may receive allowances, build an electrolyser, convert a furnace or install carbon-capture equipment and still discover that the resulting steel, chemical product or industrial heat is too expensive to operate at scale and cannot find a buyer willing to pay the green premium.

The two questions should therefore be separated. The first is whether some sectors require temporary protection while they invest. The second is how Europe will cover the operating-cost gap and create a market for the decarbonised production that follows. Conditional free allocation can be a bridge. It cannot be the destination.

Different industries face different transition barriers

A serious industrial policy must also move beyond the fiction that the same carbon price creates the same transition pathway in every sector. Europe needs a differentiated approach.

In steel, the technical routes are increasingly visible, but the green premium remains high. Early commercial plants using hydrogen-based direct reduced iron and electric arc furnaces can currently cost 50% to 140% more than conventional blast-furnace production, depending on the region. This is precisely the kind of sector in which carbon contracts for difference, low-carbon product standards and lead markets can turn a technologically feasible solution into a bankable one.

At the same time, the competitiveness problem is not created by the ETS alone. The Commission estimated in 2025 that industrial electricity prices in the EU were two to three times those in the United States and natural-gas prices nearly five times higher. Even before the energy crisis, energy represented around 17% of steel-production costs and 40% of aluminium-production costs. Weakening the carbon signal does not remove these structural disadvantages. It changes the benchmark, not the underlying performance of the European industrial engine.

The chemical industry faces an even more difficult combination of constraints. Energy accounts for around 75% of production costs in European petrochemicals, while natural gas represents more than 70% of the variable cost of ammonia. The EU has lost at least 8% to 10% of its steam-cracking capacity in three years, and announced closures could bring the loss above 20% of 2021 capacity. Many chemical activities also use fossil molecules as feedstock, not merely as an energy source, making their transition more complex than a simple process of electrification.

Here the question exceeds environmental regulation. European producers face a double penalty, structurally expensive gas and electricity, combined with Chinese and Gulf competition supported by new state of the art, often state-backed capacity. The correct policy question is not whether every existing chemical installation should be preserved indefinitely. It is: Which molecules and production capabilities must Europe continue to produce for its economic security, and how can it transform them? Temporary conditional free allocation may be justified for some critical sites, but it must be accompanied by innovation support, access to competitive low-carbon energy and a credible strategy for future operating costs.

A third category concerns strategic clean-technology supply chains that are only indirectly covered by the ETS but require support. Battery-cell prices are, on average, more than 30% lower in China than in Europe. Around half of the gap is linked to efficiency and automation, and 30% to access to lower-cost critical minerals and battery components. In rare-earth permanent magnets, China accounted for 94% of global sintered-magnet production and 91% of refined magnet rare-earth output in 2024. Some research estimated that a magnet produced in Europe cost approximately 20% to 30% more than a comparable Chinese product.

For batteries, critical-mineral refining and permanent magnets, free ETS allowances are largely irrelevant. What Europe needs are production incentives, resilience contracts, procurement criteria and lead markets that reward diversification. These instruments serve both decarbonisation and economic security. Supporting their OPEX is not a departure from climate policy; it is one of the conditions for ensuring that the technologies required by climate policy are actually produced in Europe. And for that, ETS revenues matter. 

OPEX support is the next european industrial-policy battle

Europe has traditionally been more comfortable supporting research, demonstration and capital expenditure than operating expenditure. Yet building an industrial facility is not enough if it cannot run competitively once completed.

The United States understood this clearly in the design of the Inflation Reduction Act. The Section 45X production credit provides up to USD 35 per kWh for battery cells manufactured in the United States and a further USD 10 per kWh for battery modules, as well as support equal to 10% of qualifying production costs for certain critical minerals and electrode materials. For a 70-kWh battery, the cell and module credits can amount to USD 3,150 across the domestic production chain. The US Department of Energy has concluded that the cell credit alone can offset the conversion cost (operating expenditure net of materials) and the cost of repaying capital with a healthy return. This is not simply investment aid but a deliberate attempt to change the unit economics of production.

China’s approach is different but no less structural. Between 2005 and 2024, industrial firms based in China received on average three to eight times more government support than firms based in OECD countries. It also estimates that almost 60% of the global market-share gains achieved by expanding Chinese firms in its sample can be associated with the subsidies they received. For steel specifically, China’s subsidisation rate at ten times that of OECD countries.

Can Europe respond effectively to such structural support while remaining wedded to its market-based conception of fair competition?

Europe should not copy either model mechanically. But it must abandon the belief that industrial advantages simply emerge and then remain fixed. Comparative advantage is an intellectually seductive principle. Treated in isolation, however, like a statue locked behind the walls of a pagan temple, maintained by a small number of elected priests and rarely seen by the faithful, it bears little resemblance to the political economy of the twenty-first century. The United States and China have been patiently constructing advantages through public finance, energy policy, procurement, protected demand, infrastructure and scale.

Europe needs coherent instruments to construct its own future advantages. The ETS is one of them. It makes carbon-intensive production progressively less attractive, while generating part of the public value required to scale its replacement. But the second part of this mechanism will work only if Europe explicitly directs some carbon revenues towards production-based support.

There are already European prototypes. The European Hydrogen Bank pays a fixed premium per kilogram of verified renewable hydrogen produced. The Innovation Fund’s industrial-heat auction similarly provides output-based support linked to decarbonised heat production. Demand already exceeds the available resources. In the 2025 auctions, industrial-heat projects requested EUR 1.4 billion and hydrogen projects EUR 8.4 billion, against a combined EU budget of EUR 2.3 billion. Germany’s first climate-contract round, meanwhile, offered up to EUR 2.8 billion to fifteen companies over fifteen years to compensate the additional cost of low-carbon production.

The policy technology therefore exists. The problem is scale, consistency and Europeanisation.

Turning future carbon revenues into present industrial capacity

The planned Industrial Decarbonisation Bank should become the institutional mechanism linking the two sides of the ETS. The Commission has announced an objective of EUR 100 billion, drawing on available Innovation Fund resources, additional revenues from parts of the ETS and the revision of InvestEU.This is the right order of ambition, but the financing arithmetic remains insufficiently clear.

The Innovation Fund is itself financed by the monetisation of 530 million allowances and may provide around EUR 40 billion between 2020 and 2030 at an assumed carbon price of EUR 75 per tonne. But a substantial part of that envelope has already been committed or programmed. Likewise, the Commission’s claim that the InvestEU revision could mobilise up to EUR 50 billion refers to total public and private investment, not to EUR 50 billion of budgetary expenditure capable of paying OPEX subsidies. Loans and guarantees are essential for CAPEX, but they cannot replace grants, production premiums or contracts for difference where low-carbon production is structurally more expensive.

This distinction matters. If the Bank’s EUR 100 billion is predominantly a leveraged-investment figure, its real capacity to support operating expenditure will be much smaller. The Commission should separately identify direct budgetary resources, guarantee capacity, expected private leverage and the annual commitment capacity available for long-term production contracts.

At EUR 75 per allowance, EUR 100 billion corresponds to the value of roughly 1.33 billion allowances. According to reporting ahead of the proposal, a planned initial endowment of 400 million allowances would produce EUR 30 billion at the same price, leaving EUR 70 billion to be secured. Spread across the 2028-2034 budgetary period, the remainder would require approximately EUR 10 billion per year or around one quarter of the annual ETS revenues observed in recent years.

This is politically difficult, but economically conceivable. A defined share of future auction revenues could be pledged to the Bank and brought forward through borrowing or European Investment Bank financing. The institutional precedent already exists, in February 2026, the EIB approved a EUR 3 billion facility allowing Member States to prefinance energy and transport investments by monetising revenues expected from ETS2. A comparable mechanism could transform a conservative share of future ETS1 revenues into present industrial commitment capacity.

The financing structure should follow the economic nature of the need. Direct auction revenues should finance CCfDs, fixed production premiums and resilience contracts. The European budget should guarantee the Bank against carbon-price volatility. InvestEU and the EIB should de-risk capital investment and infrastructure. Properly designed two-way contracts should allow part of the support to flow back to the Bank when carbon prices, energy prices or green-product premiums become favourable.

Most importantly, financing the Bank must not depend on creating additional allowances outside the agreed cap. Selling additional quotas may produce revenue in the short term, but it also increases supply, weakens the carbon price and reduces the value of the remaining revenue stream. Europe should not finance the industrial ‘carrot’ by hollowing out the climate ‘stick’ that makes low-carbon investment economically meaningful in the first place.

Protection now, a level playing field by 2050

European support for operating costs cannot be permanent or unconditional. Its purpose should be to allow first movers to reach scale, reduce costs and survive a period in which the international playing field is profoundly unequal.

The long-term bargain must be explicit. Europe can provide temporary protection through conditional free allocation where carbon leakage is demonstrable and strategic capacity is at risk. It can support the OPEX of genuinely decarbonised production through competitive European contracts. It can create demand through procurement and lead-market rules. In return, companies must deliver measurable emissions reductions, maintain relevant capacity in Europe and progressively become viable without open-ended support.

By 2050, European producers cannot be expected to bear the full cost of climate neutrality while highly carbon-intensive imports continue to benefit from the absence of equivalent constraints. Access to the European market should therefore require either an equivalent carbon constraint in the country of origin or the full payment of the carbon differential at the border. The purpose of the Carbon Border Adjustment Mechanism is not to end trade, but to ensure that the absence of climate policy does not remain a competitive advantage.

This is also why weakening the ETS is unlikely to solve Europe’s competitiveness problem. It would do little to lower structural energy costs, respond to foreign industrial subsidies or create markets for low-carbon products. It would, however, reduce the credibility of the investment signal and potentially shrink the future revenues required to finance industrial transformation.

The real test of the ETS reform

The ETS reform will inevitably ivolve difficult discussions about the Linear Reduction Factor, the Market Stability Reserve, free allocation, removals and the future availability of allowances after 2039. These choices are significant but they should be judged as a package, not as isolated technical adjustments. A lower reduction factor, more generous free allocation and greater releases from the reserve may each appear manageable separately while cumulatively producing a much weaker carbon price and a much smaller revenue base.

The ETS is already more than a climate instrument. It is a common European investment signal, a source of public revenue and one of the foundations on which an assertive industrial policy can be constructed. The forthcoming reform should recognise that reality.

Europe’s task should be to complete the ETS and entail it into the EU emerging industrial policy: protect strategic capacity where necessary, direct much more of its revenues towards industrial transformation, move from an almost exclusive focus on CAPEX to credible OPEX support, and do so at European rather than predominantly national level.

Copyright Tiziana FABI / AFP

The steel manufacturing giant Arcelor Mittal Italia plant, in Taranto, southern Italy.