The European Commission has proposed changes to its system of carbon emissions trading in response to the soaring energy prices caused by the war in Iran.
The EU's Emissions Trading System (ETS) has been in operation since 2005 and effectively penalises heavy carbon emitting industries via the so-called cap and trade principle.
Under the system, industries - including the electricity generating sector - pay for permits to emit greenhouse gases under a cap system, meaning that as the cap is lowered over time, in order to meet the EU's climate goals, allowances to emit carbon are also decreased.
Allowances are paid for and traded within the ETS market.
Each year carbon permits which are not taken up are cancelled. However, today the European Commission proposed ending that automatic cancellation so that spare permits would be placed in a special reserve fund.
In cases where there is a sudden spike in carbon prices - as there are currently because the Iran War has dramatically pushed up the price of gas - this special reserve fund could be released in order to lower carbon prices.
At present, if there are more than 400 million permits in the so-called "market stability reserve" then the excess is cancelled. Under the proposed changes, the excess would be placed in the reserve fund to act as a buffer.
Between 2005 and 2024, some 3.2 billion excess permits had been cancelled.
While the European Commission says that the ETS has helped produce a reduction in the EU’s greenhouse gas emissions by almost 50pc since 2025, as it incentivises industries to reduce carbon emissions, Italy and other member states have lobbied for the ETS to be suspended.
In Italy's case, this is because it relies heavily on gas to generate electricity. The cost of carbon permits has increased because the cost of gas has risen by up to 70% due to the closure of the Strait of Hormuz and Iran's attacks on LNG infrastructure in the Gulf.
The European Commission, and most member states, have argued that cancelling the ETS would reduce the incentive to switch to renewables and increase Europe's dependence on imported fossil fuels.
Under the ETS, some 10,000 power plants and factories across the EU have had to buy permits to cover their carbon emissions.
Money raised by the purchase of permits flows to member states and is invested in renewables and energy efficiency projects. Since 2013, the ETS has raised over €175 billion, according to the European Commission.
Carbon emissions in the electricity-generating sector declined across the EU by 24% in 2023 and by 11% in 2024.
Electricity and heat generation, industrial manufacturing and aviation account for roughly 40% of greenhouse gas emissions in the EU.
The EU has been phasing out the number of carbon permits as it gets closer to tougher net carbon neutrality targets.
Member states have agreed a target of reducing carbon emissions by 90% by 2040, compared to 1990 levels.
The EU introduced the so-called Carbon Border Adjustment Mechanism (CBAM) in order to dissuade industries from importing goods from abroad that are produced under less onerous carbon restrictions, a practice known as carbon-leakage.
CBAM took effect on January 1 of this year.
The proposal will need the approval of member states and the European Parliament. The Commission will carry out a comprehensive review of the ETS in July 2026.
