The European Union is facing a pivotal decision over the relationship between carbon pricing, import obligations and industrial competitiveness, with a proposed extension of the Emissions Trading System (ETS) free allowance phase-out bringing renewed uncertainty for manufacturers and international suppliers. The debate comes as importers enter the first year of binding Carbon Border Adjustment Mechanism (CBAM) obligations, placing the interaction between the two instruments at the centre of European industrial and climate policy.
The European Commission’s proposed changes would extend the period during which European manufacturers receive free carbon allowances, potentially altering the competitive conditions for steel, cement, aluminium and other carbon-intensive industries. Under the existing framework, free allowances for sectors covered by CBAM are scheduled to disappear progressively, reaching zero in 2034. The Commission’s July 2026 ETS revision proposal would extend that deadline to 2038, slowing the withdrawal of allocations.
ETS and CBAM Timetables Become Central to Industrial Competitiveness
The two mechanisms were designed to operate in parallel. The ETS establishes a carbon price for emissions generated by installations within the EU, while CBAM applies a corresponding carbon cost to selected imported products. During the transition, adjustments to CBAM certificate obligations account for the free allowances still available to European producers.
This arrangement is intended to prevent imported products, including steel and cement, from facing the full carbon charge while competing EU manufacturers continue to benefit from benchmark-based free allocations. However, the framework does not establish identical carbon costs for every industrial installation. Differences in operational efficiency, product composition, emissions accounting boundaries and national support schemes all influence the actual exposure of individual facilities.
Under the Commission’s proposed timetable, European industrial installations would retain free allocations for longer than currently envisaged. Brussels argues that manufacturers require additional time and investment support to complete decarbonisation projects while maintaining their position against international competitors.
For importers, a longer phase-out could moderate the increase in CBAM exposure over the coming years. For producers outside the EU, however, the revised schedule would change the timing of the competitive impact associated with the carbon intensity of their products. The proposed extension remains subject to the EU legislative process and does not constitute an adopted exemption from existing obligations.
Steel, Cement and Aluminium Face Different Decarbonisation Costs
The industrial implications vary considerably between sectors. Integrated steelworks must finance substantial capital expenditure to replace or modify existing production technologies. Cement manufacturers face the combined challenge of reducing emissions from fuel combustion and limestone processing, while aluminium smelters must manage electricity procurement costs alongside improvements in production efficiency.
The carbon price can encourage investment in lower-emission production, but it can also place additional pressure on industrial margins where access to financing, suitable technologies and supporting infrastructure remains limited.
The Commission’s approach seeks to address this tension through ETS revenues and investment-linked allocation mechanisms. Nevertheless, access to support differs between European installations and producers located outside the EU, creating different conditions for companies competing in the same markets.
The central policy challenge is to maintain an effective incentive for emissions reductions without accelerating the relocation of industrial investment to jurisdictions operating under less stringent carbon constraints.
CBAM Compliance Requires Separate Legal, Technical and Financial Assessments
For companies importing covered products, managing CBAM exposure requires attention to three separate areas: regulatory eligibility, emissions performance and financial settlement.
The regulatory assessment begins with the correct customs classification, the authorisation status of the declarant and confirmation that the imported product falls within CBAM’s scope.
The technical assessment concerns emissions generated at the producing installation, relevant upstream inputs and the availability of verified actual emissions data. Replacing default values with reliable installation-specific information can therefore become an important factor in determining the carbon exposure associated with an imported product.
The financial assessment covers official CBAM certificate reference prices, deductions for eligible carbon payments made in the country of production, certificate purchasing dates and the allocation of costs through commercial contracts.
These three areas can create different compliance risks within the same business. A company may have completed its regulatory preparations but lack reliable emissions data, or possess verified production information while facing uncertainty over the contractual treatment of carbon costs.
Separating the assessments allows businesses to identify whether their principal exposure comes from regulatory requirements, shortcomings in factory-level reporting or the absence of appropriate commercial arrangements. It also prevents projected carbon prices from being treated as a complete measure of CBAM compliance costs.
ETS Uncertainty Complicates International Supply Contracts
The proposed extension of the free allowance phase-out also has implications for trade agreements and industrial procurement.
Importers and suppliers need to establish which contractual party bears the financial consequences of carbon pricing, who is responsible for guaranteeing embedded-emissions information and how additional costs will be allocated if the regulatory framework changes after a shipment price has been agreed.
Contracts based on a fixed assumed CBAM charge may become exposed to changes in ETS carbon prices and adjustments to the free allocation timetable. This creates uncertainty for both buyers and sellers, particularly where agreements cover deliveries over extended periods.
Scenario-based pricing can provide a more appropriate framework for managing these risks than relying on a single carbon-cost forecast. The financial terms of supply agreements increasingly need to account for changes in carbon pricing, emissions verification requirements and the timing of regulatory adjustments.
Western Balkan Electricity Exports Face Distinct Carbon Exposure
The Western Balkans face a particularly complex set of CBAM-related challenges, with electricity potentially subject to a substantially sharper carbon adjustment than industrial products benefiting from transitional benchmark relief.
Domestic carbon taxes may reduce the amount payable under CBAM where the relevant payments meet eligibility requirements and can be properly documented. Establishing the origin and emissions characteristics of electricity deliveries is also critical.
A renewable electricity producer able to provide credible evidence of its generation may have a different compliance position from a power trader that cannot demonstrate the origin of electricity included in a scheduled delivery.
Consequently, the commercial implications for Western Balkan exporters extend beyond the regulatory framework itself. Technical reporting, generation documentation and the physical arrangements governing cross-border electricity deliveries all influence the treatment of exports.
These requirements create different exposure levels for renewable generators, electricity traders and industrial exporters operating within the region.
Legislative Uncertainty Leaves Companies Facing Two Regulatory Timelines
The Commission’s proposed 2038 endpoint introduces a further variable into the relationship between Europe’s carbon pricing system and its border adjustment mechanism. Policymakers must determine whether extending free allocations can preserve industrial competitiveness and provide 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 for subsequent years remains essential.
The existing ETS and CBAM framework continues to provide the basis for current compliance requirements, while the proposed revision remains subject to the legislative process. Businesses therefore face the need to manage binding obligations alongside uncertainty over the future pace of free allocation withdrawal and its consequences for cross-border industrial trade.
