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The European Union’s carbon market was designed to make pollution expensive without prescribing exactly how firms should cut it. That elegant idea is now colliding with industrial politics. As carbon permits become scarcer and costlier, governments fear that the policy meant to clean up European production will instead push factories, jobs and investment elsewhere.

When the carbon price starts to bite

The EU Emissions Trading System covers power generation, heavy industry and aviation. Companies receive or buy allowances for each tonne of greenhouse gases they emit, and trading determines the price. The scheme was introduced gradually, with free allowances cushioning industries that face foreign competition. Auctioning the remaining permits raised about EUR40bn for the EU and its members in 2024.

That transition period is ending. A permit now costs roughly EUR80 per tonne of carbon, with the price expected to rise as the EU reduces the supply of allowances. The article estimates that carbon pricing adds about three euro cents to each kilowatt-hour of gas-fired electricity and EUR11 to a three-hour flight. Those costs are politically conspicuous at a time of high energy prices and weak European manufacturing.

The protection given to some industries also has awkward effects. Metals and paper producers can receive more free allowances than their actual emissions, allowing them to sell the surplus for a profit. Yet removing that support exposes them to competitors operating in countries without a comparable carbon price. The result is a system that is economically coherent in theory but increasingly difficult to defend in practice.

The border mechanism leaves an export gap

The EU’s answer is the Carbon Border Adjustment Mechanism, or CBAM. Importers of carbon-intensive products such as steel and fertiliser must pay a charge reflecting the emissions embedded in those goods, unless the exporting country already imposes its own carbon price. This is intended to put domestic and foreign producers on equal terms inside the European market.

But CBAM creates a second problem. To comply with international trade rules, the EU plans to phase out free allowances for its own producers as border charges are phased in through 2034. European firms will then pay the full carbon price on goods they export, while many overseas rivals will not. Exempting exports would look like an illegal subsidy under World Trade Organisation rules.

Possible workarounds are narrow. Export credits could support genuinely low-carbon goods, rewarding efficient firms rather than every company demanding protection. Free allowances might also be tied to investment in cleaner production. Neither approach fully resolves the tension between maintaining competitiveness and preserving a strong incentive to decarbonise.

There is no painless retreat

The most consequential decision is how many allowances the EU issues. Cutting their number fast enough to meet climate targets will push the carbon price higher. Issuing more to industry would ease immediate pressure on factories, but households, farmers and transport would then have to make deeper emissions cuts. Those sectors are even more politically sensitive.

Weakening the rules would impose another cost: it would penalise companies that invested in greener processes because they trusted the carbon price to keep rising. If policymakers repeatedly soften the scheme when it becomes uncomfortable, firms will learn that lobbying may be safer than investing.

Europe’s dilemma is therefore not simply whether its carbon price is too high. It is whether the bloc can sustain a credible transition while protecting industries exposed to global competition and remaining within trade law. The ETS has reached the stage at which carbon pricing must change real economic behaviour. That is also the stage at which political support becomes hardest to preserve.