European industrial competitiveness is increasingly shaped by the combined cost of carbon, energy and production, alongside the regulatory conditions governing imports and investment. A provisional EU agreement to retain more emissions allowances in reserve has changed the framework for managing future carbon-market scarcity, but steel, aluminium and cement producers continue to face weak demand, international competition and uncertainty over the returns from industrial decarbonisation.
Under the political agreement reached on October 20, 2026, the EU would raise the market stability reserve’s allowance-invalidation threshold from 400 million to 700 million permits, subject to formal adoption. The arrangement does not require the additional allowances to be sold or released into circulation. Manufacturing costs will continue to reflect EU ETS auction prices, electricity and gas prices, production efficiency and the availability of free allocation.
The scale of the challenge is evident in European steel production. Industry association EUROFER reported that EU crude steel output fell to 125.8 million tonnes in 2025, the lowest level on record. Apparent steel consumption is expected to increase by only 0.1% in 2026, while EUROFER’s October outlook reported a 20% decline in exports to third countries during the first half of 2026. Weak construction and manufacturing activity, alongside global excess steelmaking capacity, continue to affect the sector independently of CBAM.
Production methods determine exposure to carbon and electricity prices
Steelmakers face different cost structures depending on their production technology. Blast-furnace operations generate carbon exposure through iron ore reduction and fuel consumption, while electric-arc furnaces can reduce direct emissions. However, electric-arc-furnace competitiveness also depends on scrap quality and electricity costs.
Primary aluminium production is particularly electricity intensive, whereas scrap remelting has a different direct and indirect emissions profile. Cement production presents another challenge because emissions from limestone calcination cannot be eliminated simply by purchasing renewable electricity.
These differences mean that a single EU ETS price can produce substantially different cost and investment implications across industrial sectors. Carbon-intensive producers, electricity-intensive manufacturers and businesses relying on recycled materials do not face identical incentives or operating constraints.
The Carbon Border Adjustment Mechanism, which entered its definitive phase on January 1, 2026, initially covers selected products in the iron and steel, aluminium, cement, fertiliser, electricity and hydrogen sectors. Its purpose is to align the carbon treatment of covered imports with that applied to European production.
However, manufacturers using CBAM-covered materials as inputs may face higher purchasing costs while certain imported finished goods incorporating those materials remain outside the mechanism’s current product scope. This creates concerns about potential carbon leakage further along the manufacturing supply chain.
Downstream CBAM coverage remains under negotiation
The European Commission proposed COM(2025)989 in December 2025, seeking to extend CBAM to selected steel- and aluminium-intensive downstream goods from 2028.
The European Parliament and the Council have adopted different negotiating positions, and a common final list of additional products has not been agreed. The proposed extension has therefore not become a final, adopted expansion of the product scope.
Steel and aluminium producers support extending coverage to finished products competing with European manufacturing. Some machinery, automotive and equipment manufacturers, by contrast, are concerned about additional compliance requirements and higher sourcing costs before the existing CBAM regime has fully settled into operation.
The disagreement reflects different positions within the industrial supply chain. Extending coverage could address some concerns about competition from imported finished goods, while also increasing the administrative and cost burden for downstream manufacturers purchasing materials and components internationally.
Investment decisions depend on power costs and regulatory certainty
Producers considering direct-reduced iron, electric furnaces, clean-power supplies or recycling facilities require credible long-term revenue expectations. Higher future carbon prices can improve the relative economics of lower-emission production, but may also increase the cost of operating European industrial facilities and purchasing materials.
The provisional market stability reserve agreement introduces a larger potential buffer against future allowance scarcity. Its implications for industrial investment nevertheless depend on how the reserve affects future market expectations and the resulting carbon-price outlook.
Lower expectations of extreme carbon-price movements could reduce some downside risks for manufacturers. At the same time, changes in expected allowance scarcity could affect the financial incentive to invest in costly emissions-abatement technologies. Assessing these competing effects requires project-specific cash-flow modelling rather than reliance on the reserve threshold alone.
The European Commission’s July 2026 EU ETS revision proposal introduces another variable by proposing a slower phase-out of free allocation for CBAM sectors, potentially extending the process from 2034 to 2038. The existing legal schedule remains in force because the proposal has not amended the legislation.
Investors basing valuations on a slower phase-out risk underestimating future carbon costs if negotiations produce a different outcome. Conversely, financial models that disregard the Commission’s proposal may overstate exposure under a scenario in which the proposed changes are eventually adopted.
Trade measures and market conditions also affect industrial margins
Carbon costs represent only one component of European manufacturers’ competitive position. EU steel trade safeguards, tariffs, sanctions affecting certain origins, freight rates, automotive production and currency movements also influence import volumes, selling prices and profit margins.
Changes in steel imports or market prices therefore cannot automatically be attributed to CBAM without separating the effects of these other factors.
The 50-tonne annual mass-based CBAM exemption must also be distinguished from a general exemption from customs classification and record checks for small businesses. The threshold does not mean that all smaller companies are automatically excluded from the relevant customs and documentation requirements.
The interaction between regulatory costs and commercial pricing creates further uncertainty. A European steel mill may be required to purchase emissions allowances but lack sufficient pricing power to pass the expense on to customers when global production capacity is excessive.
A downstream fabricator operating under an annual fixed-price contract may also be unable to recover an unexpected increase in steel input costs until the agreement is renewed. Depending on market power and contractual arrangements, the same carbon-price scenario can therefore affect mill earnings, processor margins or final-consumer demand in different ways.
These differences help explain why industrial groups with similar stated climate objectives can take opposing positions on whether CBAM should cover additional downstream products.
Industrial decarbonisation requires longer investment lead times
Manufacturers can introduce improvements in metering, materials accounting and energy efficiency over relatively short periods. Converting furnaces or developing carbon-capture projects, however, requires design work, permits, financing, construction and reliable long-term offtake arrangements.
Regulatory commitments made in 2026 can affect whether investors proceed immediately or wait for greater certainty about future carbon costs and industrial support measures. Delaying a project may postpone the emissions reductions that the policy framework is intended to encourage.
The central investment challenge is to provide sufficiently predictable compliance conditions for industrial projects to proceed while maintaining incentives to improve emissions performance. Carbon prices alone cannot establish the timing or financial viability of individual projects.
Western Balkan suppliers face emissions verification requirements
For manufacturers in Serbia, Bosnia and Herzegovina, North Macedonia and Montenegro, the immediate commercial challenge is to document product-level emissions at a cost and level of reliability acceptable to EU buyers.
The longer-term question for these suppliers is whether European purchasers will relocate more production within the EU, source lower-carbon materials from abroad or reorganise their industrial supply chains.
The EU’s provisional carbon-market agreement provides for greater flexibility in managing future allowance supply, while the wider debate over free allocation and downstream CBAM coverage remains unresolved. Suppliers in Southeast Europe must continue to demonstrate their emissions performance as European buyers assess procurement costs, regulatory exposure and the competitiveness of alternative production locations.
