The ETS reform. How to support industry and close the emissions gap?

A debate on reforming the European Union Emissions Trading System (ETS) is underway. On 17 July 2026, the European Commission proposed a series of changes designed to address the needs of European industry^[1]. Some proposals would ease pressure on allowance prices, while others would put pressure on industry to modernize. A key argument for continued implementation of the system is the need to reduce the EU’s dependence on imported fossil fuels.

At the same time, the Polish President has, for the second time, proposed a national referendum on whether Poles want to continue implementing EU’s climate policy. The ETS is criticised for increasing energy prices and making it more difficult for Polish and European industry to compete with companies outside the EU. Poland’s slow energy transition has also contributed to an ‘ETS gap’, in which the number of allowances allocated to Poland is lower than the needs of companies operating in the country. Yet in 2025 alone, more than PLN 17.1 billion PLN (approx. 3.9 billion EUR) from the sale of emission allowances flowed into the Polish state budget. The main beneficiaries were users of public transport^[2]. In the same year, projects worth PLN 7.4 billion PLN were contracted from the Modernisation Fund, also financed by the ETS, mainly for the thermal modernisation of single-family homes, prosumer energy and the digitalisation of district heating^[3].

What is the purpose of the European emissions trading system? Could the proposed reform benefit industry? Can Poland finally close its ETS gap? This analysis addresses these questions.

Introduction

Introduced in 2005, the European Union Emissions Trading System (EU ETS) is an instrument of European climate policy that implements the ‘polluter pays’ principle. It sets an annual cap on CO₂ emissions from sectors covered by the system — energy-intensive industry, power generation, aviation and maritime transport. The cap is divided into tradable EU Allowances (EUAs).

A company covered by the system can buy or receive free allowances, depending on the type of activity. Free allocation mainly goes to industry exposed to carbon leakage — the relocation of production to countries not covered by the system and its carbon costs — and partly to district heating. Every year, ETS installations must surrender one allowance for every tonne of CO₂ emitted.

The mechanism therefore makes polluters pay for their emissions and internalises the cost of carbon dioxide in business decisions, while preserving flexibility through allowance trading. It also supports a shift away from imported fossil fuels towards investment in domestic energy sources.

Emission reductions occur first where they are least expensive. Although emissions in ETS sectors fell by around 50% between 2005 and 2024, reductions took place mainly in the power sector and, to a lesser extent, in manufacturing^[4]. The 2023 ETS reform was intended to mobilise industry to act faster.

Industry caught off guard by CBAM

Until now, energy-intensive industry exposed to carbon leakage has been protected by several mechanisms linked to the ETS:

free allowances, which eliminated or reduced the carbon cost embedded in production;
compensation covering most of the indirect ETS cost embedded in electricity prices^[5];
access to the Innovation Fund, where industry competes for support for innovative decarbonisation projects, such as green hydrogen.

The 2023 ETS reform brought a fundamental change through the parallel introduction of CBAM (Carbon Border Adjustment Mechanism), which incorporates carbon costs into imported goods^[6]. On the one hand, CBAM encourages third countries to introduce carbon pricing and reduce emissions. On the other, its introduction means a gradual phase-out of free allocation for sectors whose imported products are covered by CBAM, including steel, cement and fertilisers.

Meanwhile, following the outbreak of the war in Ukraine^[7] and the crisis in the Strait of Hormuz, Europe came under pressure from high energy commodity prices and, consequently, higher production costs — for example for fertilisers using natural gas — as well as higher electricity prices. Energy-intensive industry is under particular pressure because it competes with companies in countries that produce their own energy resources, such as the United States, where gas and electricity prices are significantly lower.

Faced with the withdrawal of free allowances and price pressure, a large part of European energy-intensive industry called on European leaders to soften the ETS and introduce additional safeguards^[8].

At the same time, under the 2024 Antwerp Declaration, signed by more than 900 European companies from 25 sectors, EU business does not want climate policy to be abandoned. It does, however, call for a stronger role for European industry in supplying clean technologies for the energy transition and for conditions that allow it to compete with foreign companies^[9].

In response, the European Commission and Member States have launched initiatives to:

facilitate industry’s access to public funding through the Clean Industrial State Aid Framework (CISAF);
increase demand for European technologies in public procurement through the Net-Zero Industry Act (NZIA);
increase demand for European products such as green steel and cement through the proposed Industrial Accelerator Act (IAA).

Industry’s appeal coincided with the timeline for the ETS review. This created an opportunity to develop additional support mechanisms and to require Member States to redirect part of their auction revenues towards domestic industrial development.

ETS – a revenue stream Polish industry needs

The ETS is often presented only as a cost, yet it is also a very important source of national revenue. Because of its historically high emissions, Poland is among the countries with the largest auctioning allowance pool. Under Article 10 of the ETS Directive^[10], 90% of the auction volume allocated to Member States is distributed according to their historical share of verified emissions^[11]. The remaining 10% is redistributed through a solidarity mechanism supporting countries with lower income levels and greater investment needs. As a result, Central and Eastern European countries, including Poland, receive more auctioning allowances than they would solely from their share of emissions, generating higher ETS budget revenues.

Since mid-2023, 100% of revenue from the sale of CO₂ allowances must be used for climate-policy purposes. One exception is compensation for energy-intensive industry for indirect ETS costs embedded in electricity purchases^[12]. For 2025, PLN 2.9 billion was paid through this mechanism^[13].

Auction revenues flow into the state budget and are not earmarked for specific expenditures or sectors. Poland reports a broad catalogue of expenditure as ETS-related climate spending, regardless of whether a given item was directly financed from auction revenue. In 2025, the main beneficiaries were public transport users and the Polish nuclear power plant project.

Management of ETS revenue takes place within general budget procedures, with allocation decisions remaining under the responsibility of the Ministry of Finance. This gives the government considerable flexibility. However, it is not fully consistent with the idea that ETS revenues should be reinvested in sectors requiring support during the transition.

In 2021, the Ministry responsible for climate and energy developed a concept for an Energy Transition Fund that would use ETS revenue to support the transition. The project was adopted by neither the previous nor the current government. At the same time, the European Commission observed that only 5% of auction revenue is being directed to the transformation of European industry^[14].

Poland’s 2025 ETS auction revenue amounted to PLN 17.1 billion PLN. The main beneficiaries were:

public transport — 43.6%, including investment in The Central Communication Port (CPK) - now called Port Polska and the National Railway Programme;
Polish Nuclear Power Plant — 26.9%;
energy-intensive industry — 17.0%, through lower electricity prices resulting from ETS compensation;
other purposes — 12.4%, including renewable energy, the Polish electric-car project and KOBiZE activities.

This spending pattern reveals a mismatch between the sectors bearing ETS costs and those benefiting from the system. Almost half of the funds go to sectors outside the ETS, while most of the remainder supports a nuclear power plant that will reduce allowance demand only towards the end of the next decade.

The Commission’s proposal for ETS reform

In its July 2026 proposal, the European Commission presented a series of mechanisms intended both to reduce pressure on CO₂ prices and to give higher priority to emission-reduction investment in industrial sectors.

1. 50% of ETS revenue for sectors covered by emissions trading

The Commission proposes that Member States spend at least 50% of ETS revenue, excluding compensation payments, on decarbonisation investment in ETS sectors. In 2025, after excluding compensation, around 40% of Poland’s auction revenue fell into this category through support for nuclear power and renewables. If rail development were also included as a means of substituting high-emission aviation, Poland would already meet the 50% target.

2. Extension of free allocation to 2040

For sectors outside CBAM that remain exposed to carbon leakage, free allocation would be extended from 2030 to 2040. The number of free allowances is determined using product benchmarks — reference indicators for the emissions intensity of production. Only the most carbon-efficient industrial plants therefore receive 100% of the benchmark-based allocation free of charge; others must purchase the shortfall on the market.

3. Slower phase-out of free allocation in CBAM sectors

The Commission proposes extending the period of free allocation for CBAM sectors by four years, from 2034 to 2038.

4. Conditionality of free allocation

Free allocation for both CBAM sectors and other carbon-leakage-exposed industries would be conditional on preparing and implementing decarbonisation investments. 80% of free allowances would be granted after investment plans are approved by the competent national authority, while the remaining 20% would be released only after the investment is completed.

The amount of free allocation would correspond to the investment and operating costs incurred in reducing emissions. This is a major change from the current largely unconditional allocation model. Withholding 20% until completion of multi-year investments may be controversial because companies would have to buy the difference on the market, reducing their investment capacity.

5. New ETS support mechanisms

Until now, two main funds monetised part of the EU allowance pool and redistributed the proceeds to companies in Member States: the Innovation Fund and the Modernisation Fund. The reform would add a new mechanism within the Modernisation Fund and create a new instrument — the Investment Booster.

The Innovation Fund is coordinated by the European Climate, Infrastructure and Environment Executive Agency (CINEA). In 2021–2030 it will have 530 million EUAs at its disposal, worth about PLN 198 billion^[15]. After 2030 it would continue with a pool of 200–250 million allowances. Polish industry has so far secured just under PLN 3 billion from the Fund^[16].

The Modernisation Fund is an additional solidarity mechanism that redirects resources to lower-income countries. Thirteen eligible countries receive financing from the sale of 2% of the EU ETS allowance pool^[17] in 2021–2023 and 4.5% in 2024–2030. Poland receives the largest share in 2024–2030 — 34% — with the total Polish envelope estimated at around PLN 65 billion^[18]. At EU level, the fund is managed by the European Investment Bank.

The current reform would continue the Modernisation Fund at 2% and add a 0.5% pool exclusively for industry in 2031–2040. Poland would receive 38% of this additional pool. Distribution would be handled through the Industrial Decarbonisation Bank rather than the EIB, and Polish companies would compete among themselves directly for funding.

The Industrial Decarbonisation Bank (IDB) was announced as part of the Clean Industrial Deal in 2025^[19]. It is not, however, a conventional bank, but rather an institution based on the concept of the European Commission managing funds to support the development of European industry. In addition to managing part of the Modernisation Fund resources, the IDB will play a key role in implementing the Investment Booster, described below. Its operator has not yet been designated. A potential candidate is potential candidate the European Climate, Infrastructure and Environment Executive Agency (CINEA), which is currently responsible for implementing the Innovation Fund.

The Investment Booster is intended for heavy industry. In 2028–2030 it would have 400 million allowances from ETS reserves. Instead of cash, it would redirect free allowances directly to companies as a reward for decarbonisation investment. Projects would not compete with one another; allowances would be allocated on a first-come, first-served basis, subject to Commission qualification.

For countries benefiting from the Modernisation Fund, the Booster would initially reserve 25% of the total pool — 100 million EUAs. After the first 18 months, this reserved pool would fall to 60 million. Of the unused 40 million, part would move to the Industrial Decarbonisation Bank for 2031–2040, while the remaining 60 million unused allowances would go to the Modernisation Fund.

From 2031, the Industrial Decarbonisation Bank would shift from first-come, first-served support to a competitive model. It would no longer allocate free allowances directly; instead it would monetise them and redistribute the proceeds competitively. Polish industry would then compete on equal terms with companies from other EU countries.

6. Change to the Linear Reduction Factor (LRF)

Under the Commission’s July proposal, the pace at which allowances are removed from the market would be softened, while preserving a trajectory consistent with the EU’s 90% emissions-reduction target for 2040. The LRF would change:

from 4.4% per year after 2030 to 3.7% in 2031–2035;
to 1.7% from 2036, when carbon credits from projects outside the EU would begin to apply.

The Commission would sell an additional 260 million allowances resulting from the lower LRF and use the proceeds to purchase emission reductions outside the EU, which are expected to be cheaper per tonne than EU allowances. This could simultaneously increase the supply of EU allowances, lower prices and finance reductions outside the Union. The EU could thereby achieve 5% of its reduction relative to 1990 through this mechanism while maintaining the overall 90% target for 2040.

7. Changes to the Market Stability Reserve (MSR)

To reduce price pressure, the Commission also proposes easing the MSR rules. Allowances accumulated in the MSR would no longer be permanently cancelled but would remain in the reserve as a buffer that could later be used to stabilise the market. From 2028, the rate at which surplus allowances are withdrawn from auctions into the MSR would fall from 24% to 12%. From 2029, the key thresholds triggering intake and release would gradually decline by 4% per year, adapting the mechanism to the shrinking market.

Taken together, the new and reformed ETS funds, the larger allowance pool and the MSR reform could substantially improve the allowance balance in many countries, including Poland.

A renewed risk of an ETS gap

Under the Commission proposal, Poland would receive 495 million allowances in 2031–2040. This pool would comprise free allowances for industry and auction allowances, including the basic allocation, solidarity allocation, the Modernisation Fund allocation and the additional Modernisation Fund pool. From 2031, the solidarity allocation would be incorporated into the Modernisation Fund to ensure that it is used for transition investment.

The modified LRF, the slower withdrawal of allowances from the market and access to EU funds financed by ETS revenue would significantly reduce Poland’s ETS gap. After the reform, Poland’s allowance pool in 2031–2040 would increase by 37%, from 362 million to 495 million allowances.

Full and timely implementation of Poland’s National Energy and Climate Plan (NECP)^[20] under the With additional measures scenario, combined with the proposed ETS reform, would substantially reduce the negative balance of Polish allowances.

The projected ETS gap in the WAM scenario is 607 million EUAs before the revision and 222 million after it. With a slower transition and limited renewable investment (With existing measures scenario), the gap would still amount to 514 million tonnes of CO₂ even after the ETS revision.

The proposed changes to the functioning of the EU ETS – including new and reformed ETS funds, an increase in the supply of allowances, and the reform of the Market Stability Reserve (MSR) – could significantly improve the allowance balance in many countries, including Poland.

How can Poland close its ETS gap?

Implementation of the NECP would significantly reduce the national ETS gap. Nevertheless, the remaining negative balance of 222 million allowances is still a cost worth avoiding. There are two principal ways to close it.

1. Secure more support from the Innovation Fund and use the Investment Booster

The Innovation Fund has so far been used only to a limited extent by Polish industry. Its available funding comes from the auctioning of roughly 40 million allowances each year. In 2021–2025, Polish companies secured funding equivalent to only around 8 million allowances. Poland’s climate ministry hosts a national Innovation Fund contact point supporting industry in accessing these resources^[21]. Because the Innovation Fund is competitive, obtaining significantly more support will remain challenging.

The Investment Booster should be easier for Polish companies to access, first because eligible lower-income countries receive priority access to 100 million allowances in 2028–2030, and second because some unused allowances from this pool would move into national Modernisation Fund envelopes.

Assuming Polish companies reduced emissions in line with the NECP, continued to use the Innovation Fund at the current pace and secured 14.4% of the available Investment Booster pool — corresponding to Poland’s share of total ETS emissions^[22] — the national ETS gap would be almost eliminated.

2. Further reduce emissions in installations covered by the system

Increasing the share of renewable energy in power and district heating and accelerating electrification are the most durable ways of reducing the ETS gap in the long term. Every tonne not emitted increases flexibility in the national allowance balance. The development of onshore wind has been constrained since 2016; industry has faced barriers to developing its own generation; and Poland has one of the EU’s lowest electrification rates, including in heating. Removing these barriers can further reduce the allowance deficit.

Forum Energii’s analysis of electrification in Poland indicates that the current electrification rate — one of the lowest in the EU — could rise from 17.4% to 42.9% by 2040. In addition to estimated final-energy savings of 15%, higher electrification in industry and heating would reduce emissions and narrow the ETS gap.

Recommendations

Energy crises and growing competition from China and the United States have forced the EU to rethink its approach to industry. ETS reform is an important part of this shift, alongside forthcoming requirements to purchase EU-made components in public procurement. Continuing the ETS demonstrates the EU’s determination to modernise not only the energy sector but also industry.

Maintaining the system comes with new requirements for a transition that reduces both emissions and the EU’s dependence on imported fossil fuels. The debate in Brussels is an opportunity for Poland to negotiate a framework that mobilises industry to modernise while preserving competitiveness. This will require coalition-building within the EU, but above all political will and a strategic approach in Warsaw to the redistribution of ETS resources.

Key priorities at EU level

Create national envelopes in the Innovation Fund and the Investment Booster. In exchange for conditional free allocation, Polish industry should have guaranteed access to funds and free ETS allowances. This would also help close the national ETS gap, provided the WAM pathway of the NECP is implemented.
Front-load support in exchange for conditionality. Industry needs investment today to change production processes in the next decade. The Investment Booster and resources from the Modernisation and Innovation Funds should therefore be provided in larger tranches at the early stage of industrial investment. This should cover the gap created by withholding 20% of free allocation until investments are completed, if that rule survives negotiations. A start-up bonus should also reduce project risk and financing costs.
Reduce the stringency of free-allocation conditionality. Conditionality should be limited to creating investment plans. Withholding 20% of allowances until completion and tightly linking allocation volumes to investment value may be excessively burdensome. Requiring a transition plan in exchange for free allocation is less controversial, as similar obligations already exist under the Energy Efficiency Directive^[23].
Diversify support by technology. Industrial sectors differ in their decarbonisation options and electrification potential. Process change is easier and cheaper in some sectors, such as food processing, than in cement, where CCS is a principal decarbonisation option. These sectors should not have to compete directly against each other for free allowances; support programmes should reflect this diversity.

Actions at national level

Develop an industrial transition support strategy. Poland should create a comprehensive strategy for using all existing and future industrial support mechanisms. Closing the investment gap for new technologies through the Modernisation Fund and Investment Booster can help initially, but a system for reducing electricity costs — including through ETS resources and CISAF — is also required.
Create a national Transition Fund financed with revenue from allowance sales. The Fund should become the principal instrument for planning investment in line with the adopted NECP.
Make it easier for industry to use its own energy sources. Simplify rules for on-site generation, including allowing occasional or limited sales of surplus electricity without requiring a full electricity-sales licence and without losing a simple self-consumption model. For direct lines, removing the requirement to involve a separate trading company and reviewing the solidarity charge would be helpful.

Annex. Support instruments after the proposed ETS reform

Source: Forum Energii own analysis based on the European Commission proposal for ETS reform, Climact data and assumptions concerning the Modernisation Fund.