On 21st October 2025, the European Commission unveiled a new policy package introducing structural adjustments to the forthcoming EU Emissions Trading System 2 (ETS2). The measures respond directly to the growing concerns expressed by several Member States over potential price volatility and the social implications of extending carbon pricing to the buildings and road transport sectors from 2027.
Commissioner Wopke Hoekstra, presenting the initiative, underlined that the credibility of Europe’s carbon markets depends not only on their environmental effectiveness but also on their social and economic fairness.
“The clean transition will only be successful if it is fair across society. It must address the climate crisis, but just as importantly, spur EU competitiveness and strengthen our strategic independence… Fair prices, particularly for those with lower and middle income, are an absolute necessity.”
The announced changes aim to ensure that the ETS II achieves both objectives: a predictable and cost-efficient reduction of emissions and a fair burden distribution across households and businesses. By enhancing cost-containment mechanisms, accelerating auctioning, and providing fiscal flexibility to Member States, the Commission seeks to prevent excessive price spikes while maintaining the integrity of the cap-and-trade system that has successfully driven down industrial and power-sector emissions by more than half over the past two decades.
Announced Measures
1. Increase of the Market Stability Reserve (MSR) intervention limit to 80 million allowances per year under the cost-containment mechanism.
2. Start of auctioning in 2026, one year earlier than initially foreseen.
3. Retention of allowances in the reserve after 2030, removing the automatic invalidation rule.
4. Permission for Member States to borrow against future ETS II revenues to finance national decarbonisation and social-climate schemes.
These decisions introduce more liquidity and earlier revenue circulation into the system, with the explicit objective of moderating near-term price shocks.
Quantitative Assessment
The following assessment is derived from ENCOSE’s proprietary ETS II market model, which integrates sectoral emission trajectories, fuel-switching elasticities, and marginal abatement-cost (MAC) curves for the building and transport segments.
The model evaluates both the supply-side structure (cap trajectory, auction calendar, MSR responsiveness) and the demand-side dynamics (energy substitution potential, income sensitivity, and fiscal transfers through national decarbonisation programmes).
Under the pre-announcement framework, the simulated equilibrium prices reflected a steeply rising cost curve once front-loaded volumes were absorbed and the Market Stability Reserve (MSR) began to constrain supply.
Estimated allowance price intervals under these baseline conditions were:
Adjustments applied after the OCT-25 policy changes
Each new policy variable announced by the Commission affects either effective supply elasticity, forward liquidity, or price expectations.
The following coefficients were applied to model the new scenario:
Following the policy adjustments announced on 21 October 2025, the model was re-parameterised to account for:
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an expanded MSR cost-containment capacity allowing up to 80 million allowances per year to be released when trigger conditions are met,
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the advancement of auctioning to 2026, introducing earlier liquidity and revenue flows,
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the removal of the post-2030 invalidation rule, which stabilises long-term expectations, and
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the introduction of a borrowing facility enabling Member States to mobilise future ETS II revenues in advance.
From a quantitative standpoint, the doubling of potential MSR intervention increases short-term supply elasticity by approximately 0.3 points, while the earlier auctioning shifts roughly 100 million allowances into the market’s initial compliance phase.
Together, these measures lower the marginal scarcity premium embedded in forward pricing curves and flatten the steep portion of the 2028-2030 cost curve.
This represents a 30–35 percent reduction from the pre-reform trajectory and reflects a structural transition from a low-elasticity, deficit-driven market to a more balanced configuration in which policy instruments act as endogenous stabilisers rather than external interventions.
While this adjustment modestly reduces the system’s short-term stringency by expanding available liquidity during the initial compliance years, it substantially enhances price predictability and market confidence among obligated parties. The combination of an expanded MSR and the removal of the post-2030 invalidation rule provides a smoother forward price trajectory, mitigating fears of abrupt shortages or speculative tightening beyond 2030. Together, these elements strengthen the system’s credibility and improve its capacity to deliver emissions reductions at lower social and fiscal cost.
Re-simulation of the system under these new parameters yields a revised price corridor of 50–105 €/t CO₂ for 2027–2030, with a central estimate around 75 €/t CO₂ in First Fase period.
Market and Policy Implications
Market Balance
The extension of the MSR and the early auctioning schedule increase near-term supply, flattening the forward curve. The 2026–27 vintages will likely trade at a discount compared to the original design. Medium-term scarcity remains, but the post-2030 retention of the reserve prevents extreme tightening later in the decade.
Price Stability
The new 80 Mt per-year ceiling effectively doubles the market’s cost-containment capacity. Even in high-demand years, any two-month average above the soft-cap threshold (~€45/t in 2020 prices) would now trigger larger releases and should prevent the volatility observed in ETS Phase III.
Social and Fiscal Dimension
By enabling borrowing and earlier auctioning, Member States can finance social-climate measures and infrastructure ahead of the system’s start. This aim to address one of Hoekstra’s central points: fairness and competitiveness must go hand-in-hand. The approach mirrors a limited-scope “green bond” model using future ETS revenues as collateral.
Environmental Ambition
While the measures marginally weaken short-term stringency (expected emission reduction ≈ -38 % vs. 2005 instead of -40 %), they aim to enhance more of political durability. The likelihood of national resistance to ETS II implementation is expected to diminish as fiscal flexibility and price predictability improve.
The reform announced on 21 October 2025 represents a structural recalibration rather than a redesign of the ETS II. By expanding the Market Stability Reserve and removing the post-2030 invalidation rule, the Commission introduces a smoother long-term price trajectory and reduces the risk of abrupt scarcity shocks. The earlier auctioning schedule and the new revenue-borrowing mechanism strengthen the fiscal linkage between carbon pricing and national climate spending, enabling governments to manage the transition with greater predictability and social balance.
Overall, the revised framework transforms ETS II into a more resilient and credible market instrument one capable of sustaining decarbonisation while maintaining fairness and stability. The system’s strength now lies in its flexibility: it can react to volatility without undermining its environmental integrity, providing both policymakers and market participants with the continuity and confidence needed for long-term investment.
