The EU ETS and the 2040 Climate Target

The report finds that current EU ETS cap trajectories are more ambitious than required by most climate neutrality scenarios, potentially leading to severe allowance shortages and price spikes after 2035. It evaluates several reform options to balance supply and demand, including adjusting the linear reduction factor (LRF), reforming the Market Stability Reserve (MSR), and integrating carbon dioxide removals (CDRs). The authors warn against the inclusion of Article 6 international credits due to risks to environmental integrity and the potential for market collapse. Recommended solutions include a combination of MSR replenishment and technological CDRs or a phased reduction of the LRF post-2035.

• Current EU ETS cap trajectories are more ambitious than necessary to reach climate neutrality by 2050, as emissions from covered entities do not need to reach zero by that date even in the most ambitious Paris Agreement-aligned scenario.
• A critical shortage of market liquidity is projected to occur after 2035, when the demand for EU Allowances (EUAs) exceeds supply, potentially causing unsustainable price hikes and increasing the risk of carbon leakage or business closures.
• Merging the EU ETS 1 and ETS 2 is not recommended as a primary tool for increasing liquidity because its effectiveness is highly sensitive to emission projections and it presents significant administrative barriers and risks of delaying decarbonisation in sectors with a higher willingness to pay.
• The inclusion of international carbon credits under Article 6 of the Paris Agreement poses a severe risk to the EU ETS, potentially flooding the market with low-quality credits and causing EUA prices to collapse, similar to the historical experience with the Clean Development Mechanism (CDM).
• Technological carbon dioxide removals (CDRs), such as BECCS and DACCS, could provide some liquidity, but their high costs, uncertain scalability, and timing make them unreliable as a standalone solution for addressing allowance shortages before 2040.
• Adjusting the linear reduction factor (LRF) post-2035 can effectively maintain liquidity; for example, reducing the LRF to 2.2% from 2035 and 1.1% from 2040 would keep the Total Number of Allowances in Circulation (TNAC) positive until 2049 in the CTP2.5 scenario.
• Reforming the Market Stability Reserve (MSR) through a replenishment mechanism—where the MSR is refilled if holdings fall below a certain threshold—is a flexible way to increase supply that only triggers when there is a genuine market shortage.

APA

Graichen, J., Skribbe, R., Gores, S., Lauer, S., & Hennenberg, K. (2025). The EU ETS and the 2040 Climate Target. Carbon Market Watch. https://carbonmarketwatch.org/wp-content/uploads/2025/06/EU-ETS-and-2040-climate-target.pdf

Chicago

Graichen, Jakob, Reena Skribbe, Sabine Gores, Sophia Lauer, and Klaus Hennenberg. The EU ETS and the 2040 Climate Target. Carbon Market Watch, 2025. https://carbonmarketwatch.org/wp-content/uploads/2025/06/EU-ETS-and-2040-climate-target.pdf.

Wikipedia

{{cite report |last1=Graichen |first1=Jakob |last2=Skribbe |first2=Reena |last3=Gores |first3=Sabine |last4=Lauer |first4=Sophia |last5=Hennenberg |first5=Klaus |title=The EU ETS and the 2040 Climate Target |publisher=Carbon Market Watch |date=16 June 2025 |url=https://carbonmarketwatch.org/wp-content/uploads/2025/06/EU-ETS-and-2040-climate-target.pdf |access-date=23 October 2026 |via=Climate Insights Directory}}

BibTeX

@techreport{graichen2025ets, author = {Graichen, Jakob and Skribbe, Reena and Gores, Sabine and Lauer, Sophia and Hennenberg, Klaus}, title = {{The EU ETS and the 2040 Climate Target}}, institution = {Carbon Market Watch}, year = {2025}, month = jun, url = {https://carbonmarketwatch.org/wp-content/uploads/2025/06/EU-ETS-and-2040-climate-target.pdf}, urldate = {2026-10-23}, note = {Indexed by Climate Insights Directory} }