European Carbon In Transition: ETS1, ETS2, And The Investment Outlook

2025-07-24 14:20:00 ET

Introduction

For a couple of years since the “Fit-for-55” reform package became law, the European carbon market has been driven mostly by the economy and coal-to-gas switching, as the regulatory activity slowed down. We are now entering a phase where regulatory developments are accelerating, many of which have the potential to tighten the supply-demand balance and, as a result, provide tailwinds for European Union carbon allowances (EUAs):

• New Sectors Added to CBAM Legislative review of Carbon Border Adjustment Mechanism (CBAM) in the second half of 2025 has a strong possibility of expanding its scope to additional sectors as well as the downstream supply chain. CBAM serves as a carbon tariff on imports for select high-emitting products into the EU. This expansion could drive up hedging demand from importers into the EU, increasing the demand for carbon allowances.
• Inclusion of International Aviation The CORSIA (Carbon Offsetting and Reduction Scheme for International Aviation) assessment by the European Commission in 2026 may result in extending the coverage of the EU Emissions Trading System ((ETS)) to include international aviation. Should this occur, there will be additional traded demand entering the European carbon market.
• REPowerEU Receeding The tail phase of REPowerEU starting in 2027, where auction supply will be reduced to compensate for extra allowances auctioned in 2023-2026. 57Mt of allowances are expected to be withheld from auctions each year from 2027 through 2030, reducing supply by 6%.

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