Trends in carbon intensity and the macroeconomic role of the EU Emissions Trading System

The EU Emissions Trading System (ETS) is a key element of the EU policy framework to achieve at least 55% net greenhouse gas (GHG) emission reductions in 2030 compared to 1990. This Special Issue analyses ETS price transmission channels and economic impacts with a focus on inflation, identifying three main results. First, the economic impacts of carbon pricing in the existing ETS are still mainly channelled through electricity prices. Second, the gradual transition of the protection regime against carbon leakage risk to the new Carbon Border Adjustment Mechanism (CBAM) has a negligible impact on inflation over the forecast period. Third, the near doubling of the ETS scope to include buildings, road transport and additional sectors (ETS2) is expected to raise consumer energy prices in the first year of application. However, this impact will vary across EU Member States. The analysis presented here also shows that the EU economy has decarbonised more than other major economies, in particular in sectors covered by the ETS.

The EU Emissions Trading System (ETS) enables a market-driven approach to reduce CO₂ emissions in a cost-efficient way. By capping the total emissions permitted and allowing companies to trade emission allowances, the system incentivises businesses to adopt greener technologies. Otherwise, they pay a price for their emissions by purchasing allowances from those more efficient at reducing emissions.

The coverage of the ETS has expanded over time. The ETS was introduced in 2005 as a central tool to reduce greenhouse gas emissions (GHG). The scheme initially covered CO₂ emissions from electricity and heat generation, as well as some energy-intensive industries. Its coverage has been extended over time: in 2013 to all other major energy-intensive industries and intra-EU aviation, and in 2024 to maritime transport. The current system (now called ETS1) covers around 40% of EU greenhouse gas emissions. 

The ETS uses a cap-and-trade model to establish a carbon market with an EU-wide carbon price. The ETS directive (2003/87/EC) sets an EU-wide emission cap for the activities covered by the system. For ETS1, the cap declines every year with a linear reduction factor that has been amended several times since 2013 and is now aligned with a 62% emission reduction by 2030 ^([46]). The cap determines the total number of emission allowances available. Each regulated entity is required to annually surrender allowances equivalent to its emissions. Allowances are primarily distributed through auctions, with entities able to trade unused allowances on the secondary market. This establishes a common carbon price across the EU. 

The ETS1 carbon price has increased to levels well above EUR 50 per ton of CO₂ since 2021. The introduction of the Market Stability Reserve in 2018 helped to re-balance supply and demand of allowances, lifting ETS1 carbon prices from previously low levels. Subsequently, the strengthening of ETS1 in line with the target to reduce net greenhouse gas emission by at least 55%, together with the energy crisis caused by Russia’s war of aggression against Ukraine, pushed average carbon prices up to EUR 80 in 2022-2023, before they decreased to EUR 65 in 2024. In 2025, prices have so far fluctuated between EUR 60 and EUR 80 (see Graph II.1.1). Future markets signal only slight ETS1 price increases by 2027: around EUR 2 higher in December 2026 than in December 2025, and EUR 4 higher in December 2027, with limited liquidity on the future market beyond 2026. ^([47])

As of 2026, the Carbon Border Adjustment Mechanism (CBAM) will gradually replace the free allocation of ETS1 allowances as the main policy tool to mitigate carbon leakage risks. Carbon leakage refers to an increase of emissions in non-EU countries resulting from the relocation of CO₂ intensive production outside the EU due to carbon pricing. To mitigate the risk of such increases, energy-intensive industries in the EU currently receive a significant amount of free ETS1 allowances, accounting for nearly half of all emissions of ETS1 stationary installations in 2024. The CBAM will ensure that the ETS1 carbon price also applies to imports, thereby levelling the playing field for EU and non-EU producers on the EU internal market. It covers electricity, iron and steel, aluminium, cement, fertilisers, and hydrogen products, corresponding to around 54% of the free allowances under ETS1 in the period 2021–25. The transition to CBAM will be gradual: ETS1 free allowances for CBAM-covered sectors will be reduced by 2.5% in 2026 and 5% in 2027, and the ETS1 carbon price will be applied at the same low rates to imports from countries lacking equivalent carbon pricing. 

Carbon pricing will be extended to additional sectors through a separate emission trading system. The new ETS—referred to as ETS2—covers CO₂ emissions from fossil fuels used in buildings, road transport and industries not covered by ETS1, e.g. industrial heating in non-energy intensive sectors, small district heating, SME emissions. ETS2 nearly doubles the share of EU GHG emissions covered by carbon pricing, to around 75%. Member States also have the option to include emissions from additional sectors within its scope, e.g. fuels used in agriculture, for mobile machinery, in inland navigation or by small planes. ^([48]) ETS2 is a new instrument in the toolbox of EU and national policies to help Member States achieve national emission reduction targets, in addition to excise duties for energy, carbon taxes and regulatory and support measures. The ETS2 emission cap will decrease linearly to achieve a 42% emission reduction by 2030 compared to 2005. 

The date of entry into operation of ETS2 is uncertain. The ETS directive (2003/87/EC) as amended in 2023 sets 2027 as first year of operation of ETS2. However, on 5 and 13 November, respectively, the EU Environment Council and the European Parliament each agreed to postpone the entry into operation of ETS2 by one year. ^([49]) The postponement must be confirmed in negotiations between both institutions and subsequent votes before it can become applicable.

The design of ETS2 includes mechanisms to avoid excessive carbon prices. Just like ETS1, ETS2 will operate with a dedicated, rule-based Market Stability Reserve to manage imbalances in the supply and demand of allowances on the market. The frontloading of auctioning ensures a liquid market from the start. Several other mechanisms have been established to prevent excessive price increases. Notably, additional allowances will be released from the reserve when the ETS2 carbon price reaches EUR 45 per ton CO₂ in 2020 prices ^([50]) (corresponding to EUR 58 in 2027 ^([51])). In addition, on 21 October, the Commission announced that it would soon present a package of proposals to address concerns about future ETS2 carbon price levels and volatility. ^([52]) 

The ETS generates revenues which are used for climate-related investments and to mitigate the social impacts of carbon pricing. Most ETS1 allowances are auctioned, with the proceeds primarily allocated to Member States, and partially to the Modernisation Fund, the Innovation Fund and RePowerEU under the RRF. By mid-2025, the EU ETS had raised EUR 245 billion in revenues through the sale of emission allowances since its launch. Under ETS2, all emission allowances will be auctioned to generate public revenues. A part of these revenues will be allocated to the Social Climate Fund (i.e. EUR 65 billion in 2026-32), to help mitigate the price impact of ETS2 on vulnerable households, transport users and micro-enterprises, but the majority will go directly to Member States, to be used primarily for social purposes. 

Trends in the carbon intensity of the EU economy and the role of the EU ETS 

The decarbonisation of the EU economy started in the 1990s and continues to accelerate. EU CO₂ emissions increased by 9% between 1970 and 1990 despite the two oil shocks, before decreasing by 10% between 1990 and 2010 and by 28% between 2010 and 2024 ^([53]). The carbon intensity of the EU economy, expressed in CO₂ emissions per unit of GDP, decreased even more, by 37% between 1990 and 2010 and by a further 41% between 2010 and 2024.

The EU is a frontrunner internationally in terms of decreasing the carbon intensity of its economy. The carbon intensity of the EU economy has decreased to 101 tons CO₂ per million GDP (measured in USD for comparison purposes) in 2024, compared to 170 tCO₂ in Japan, 180 tCO₂ in the United States, and 391 tCO₂ in China (see Graph II.1.2). The carbon intensity of EU Member State economies ranges between 56 tCO₂ in Sweden and 168 tCO₂ in Poland. ^([54]) Starting from higher carbon intensity levels, China and the United States have also decarbonised at a similar pace as the EU over the last twenty years (EU -48%, China -48%, US -46% between 2005 and 2024), whereas Japan has seen slower progress (-30%). Over the last decade, the EU has seen the largest decrease, at 31% (see Graph II.1.2).

The EU ETS has helped to accelerate the decarbonisation of the EU economy. The carbon intensity of EU ETS1 sectors has decreased by 62% since 2005, compared to a 48% decrease seen in the overall EU economy. Since 2015 alone, carbon intensity has decreased by 45%. For comparison, the carbon intensity of sectors which will be covered by ETS2 only decreased by 36% between 2005 and 2023, and 19% since 2015 (see Graph II.1.2). Scientific studies of ETS1 confirm that efficient economic instruments which incorporate climate costs into market prices play a key role in decarbonising the economy. ^([55]) 

ETS price transmission and economic impacts 

ETS1 carbon prices are still primarily channelled through electricity prices. Electricity and centralised heat generation still account for the largest share of ETS1 emissions, at 50% in 2024, though this share is rapidly decreasing. The power sector is by far the largest purchaser of auctioned ETS allowances. The main price transmission channel is the wholesale electricity price. When the marginal producer setting the market price is a fossil fuel power plant, the market price is expected to include the carbon cost of that fuel. Bai and Okullo (2023) estimate a full cost pass-through of carbon prices to wholesale power prices in Belgium, Germany, Italy, the Netherlands, Scandinavia, and the United Kingdom for the period 2008-18, while Dagoumas and Polemis (2020) estimate an almost complete pass-through in Greece. ^([56]) If the marginal power plant uses gas, the price impact is lower than if it uses coal.^([57]) However, in fifteen Member States, the impact of ETS1-related increases in electricity prices on energy-intensive industries is mitigated by compensation mechanisms. ^([58]) 

The direct impact of ETS1 on the costs of industries which heavily use fossil fuels is mitigated by free allowances. In 2024, 38% of ETS1 emissions stemmed from industrial processes ^([59]) in energy-intensive industries. ETS1 emission allowances allocated for free to these industries and to district heating have broadly matched their emissions, thereby limiting their carbon costs. Neuhoff and Ritz (2019) highlight significant variation and uncertainty in ETS1 carbon cost pass-through to basic material prices across countries and sectors, with full pass-through observed in only a few cases. ^([60])

The main ETS2 price transmission channel is retail prices of fossil fuels. While ETS1 primarily impacts electricity prices, ETS2 will add carbon costs to fuels used in buildings and road transport, thus creating a more level playing field between different uses of fossil fuels. Given that around two thirds of ETS2 emissions are household fuel emissions, ETS2 will impact consumer prices directly by raising retail prices for oil (petrol, diesel, heating oil), gas and coal. In addition, indirect price impacts are anticipated, as higher fuel prices for fossil-fuelled road transport and heating affect producers of consumer goods and services. The ETS2-regulated entities are expected to pass on the ETS2 carbon price fully to their customers, as is the case for existing excise duties. However, the increase in gas prices may be more gradual, reflecting the duration of existing contracts and specificities related to domestic energy markets (e.g. the degree of price control).

Increases in electricity and fuel prices due to carbon pricing tend to have a greater impact on lower-income households than higher-income ones. The impact is found to be most significant for the two lowest income deciles. However, the overall effect hinges on the extent to which ETS revenues are used to offset the price increases for these households. The additional revenues generated by ETS2 should be sufficient to fully compensate regressive impacts. ^([61]) 

The impacts of the EU ETS on growth and productivity are assessed to have been small to moderate to date. Empirical analyses of the impact of the ETS1 so far have mostly found either negligible or positive impacts on firm productivity and investment. ^([62]) The EC (2020b) ex-ante macroeconomic impact assessment of strengthened and extended carbon pricing (ETS1 and ETS2) points to GDP impacts in 2030 between -0.39% and +0.13% compared to the baseline scenario. Sectoral output in different energy-intensive industries is projected to decrease in 2030 between 0.1% and 4%. ^([63]) An ex-ante macroeconomic assessment of strengthened carbon pricing in Varga et al (2022) reports GDP impacts between -0.61% and -0.91% in 2050, depending on the use of carbon pricing revenues. ^([64]) 

The inflationary impact of ETS1 has been found to be limited so far. Buelens (2024) provides a conceptual and literature-based overview that suggests that ETS1 has had a moderate impact on inflation. ^([65]) Bettarelli et al. (2025) do not find statistically significant effects of emissions trading systems on prices in the period from 1989 to 2022, while Morao (2025) points to inflationary impacts of the ETS1 carbon price increases in 2022. ^([66]) In the medium-term, however, the price effect could be larger as the emissions cap decreases and free allowances are phased down. EC (2021b) energy system modelling points to ETS1 carbon price increases between 2025 and 2030 of around EUR 20 (including inflation). ^([67]) The European Economic Forecasts have been incorporating the transmission of ETS1 prices to electricity-related production costs and consumer inflation. This incorporation occurs implicitly through electricity price assumptions, which are based on wholesale futures prices.

The implementation of CBAM is expected to have a negligible impact on inflation in the short term. Due to the very gradual phase out of ETS1 free allowances and the corresponding phase-in of CBAM, the average increase in carbon costs for industry compared to 2025 prices is calculated at around EUR 1 per ton CO₂ in 2026 and around EUR 2 in 2027, while the price of the carbon content of imported products covered by CBAM is estimated to increase by around EUR 2 per ton CO₂ in 2026 and around EUR 4 in 2027. In 2030, according to EC (2021c) CBAM-related sectoral product price increases are estimated to range between 0.02% and 0.06% for most sectors when compared to a baseline that includes ETS1 only. The estimated increase is 0.08% for personal transport equipment and 0.12% for fuels and power. ^([68]) 

There is uncertainty surrounding the ETS2 carbon pricing, including in its first year of application. In the EC (2021b) ETS impact assessment, the modelled ETS2 carbon price for 2030 is EUR 48 per ton CO₂ in 2015 prices, corresponding to EUR 69 in 2030 prices ^([69]). Initial ETS2 carbon prices are expected to be lower due to the above-mentioned mechanisms designed to enable a smooth start to ETS2. These include frontloading of auctioning and the release of additional allowances from the Market Stability Reserve once the carbon price reaches the trigger level (for 2027 it would be EUR 58). For analytical purposes, EC (2025) provided estimates of the annual carbon price resulting from ETS2 ^([70]). For 2027, this value would be EUR 30 per ton CO₂ in 2023 prices, corresponding to EUR 33 in 2027 prices. Other analyses suggest that ETS2 carbon prices may be higher, but estimates vary widely. This European Economic Forecast assumes an ETS2 carbon price of EUR 46 in 2027, which is the average of the EUR 33 estimate and the intervention price of EUR 58. There are three main reasons for different estimates and related uncertainty: i) the uncertainty surrounding the emission level at the start of ETS, ii) the interplay between carbon pricing and other regulatory policies, and iii) uncertainty around the foresight of key actors on the ETS2 carbon market. ^([71])

Despite an initial inflationary impact, over time ETS2 is expected to protect the economy from fossil fuel price shocks. Although the introduction of ETS2 is likely to have an almost immediate impact on consumer energy and headline inflation, over time it is set to play a crucial role in mitigating the adverse effects of fossil fuel price volatility. Fossil fuel prices are inherently volatile, as recently demonstrated by the fallout of the Russian war of aggression against Ukraine. By supporting decarbonisation through carbon pricing, ETS2 will help reduce the economy's vulnerability to fossil fuel price shocks. ^([72]) 

The impact of ETS2 on energy prices varies greatly across sectors and countries. Retail energy price increases through ETS2 are expected to vary between fuels, sectors, and Member States. The EC (2021b) analysis for a carbon price of EUR 48 per ton CO₂ yielded absolute price increases of EUR 0.11 and 0.13 for petrol and diesel, corresponding to relative price increases in Member States ranging from 7% to 14%. For heating oil and gas, the relative price increases in Member States were estimated to be between 10% and 30%, while price increases for heating coal were estimated at 52% on average. These differences across Member States also reflect wide variations in the share of energy taxation. Indeed, this is demonstrated by the implicit carbon prices calculated by OECD (2024), showing effective carbon prices in 2023 ranging from EUR 114 to 263 per ton of CO₂ in road transport and EUR 3 to 312 in buildings. ^([73]) Countries that heavily rely on high-carbon-content fossil fuels for their energy needs will incur higher consumer energy price increases. By contrast, in Germany and Austria, ETS2 is likely to lead to no impact or even negative impact, as it will replace existing national emissions trading systems which currently have lower carbon pricing. Ireland and Luxembourg have requested a temporary ETS2 derogation, allowing only national carbon taxes to apply if they exceed the ETS2 carbon price in a given year. 

ETS1 and ETS2 provide a financial incentive to decrease reliance on fossil fuels by shifting to more sustainable, cheaper energy alternatives and improving energy efficiency. While short-term price elasticities of demand are limited, in particular in ETS2 sectors, they increase in the longer term. ^([74]) This implies that in the short term, the price effect will dominate while over time carbon pricing promotes a shift toward cheaper renewable energy sources and greater investment in energy efficiency. These changes will reduce the carbon intensity of the economy.