EU plan to fold 250m tonnes of permanent removals into ETS cap faces surplus test
Brussels wants unlimited permanent carbon removals in the EU ETS, raising fundamental questions about allowance scarcity and the market's price signal.
The European Commission's draft ETS review, unveiled on Friday (2026-07-17), proposes integrating up to 250 million tonnes of eligible permanent domestic carbon removals into the EU ETS, with the cap increased to accommodate them. The measures also include changes to the market stability reserve (MSR) to make it more dynamic and responsive, plus an "investment booster" providing 400 million EU allowances worth an estimated €30bn directly to industry for fast decarbonisation projects.4
Two policy goals are now pulling in opposite directions. The Commission says it is preparing for an expected shift from surplus carbon allowances to scarcity in the coming years, yet allowing unlimited permanent removals into the system could delay that tightening by expanding the cap to absorb them.4
The removals proposal is the sharpest edge of the review. Brussels is effectively raising the ETS cap to make room for carbon removal credits, a design choice flagged by market participants in early June (2026-06-04).2 The cap increase means the scarcity the Commission says it is preparing for may arrive later than its own modelling suggests.4
Traders have been here before. The ETS has spent most of its existence fighting surplus, not scarcity. The MSR was built to absorb that glut, and the new proposal makes it more responsive to price signals.4 But a dynamic MSR cuts both ways: it can withdraw allowances faster when prices fall, yet it can also release them when prices spike, which caps the upside for anyone holding long positions.4
The removals integration adds a further complication. Permanent removals are not abatement; they are atmospheric cleansing, and they do not require an industrial emitter to change behaviour. Allowing them into the ETS means emitters can buy removal credits instead of cutting their own emissions, which weakens the incentive to invest in on-site decarbonisation.5
The free allocation regime is also being pulled tighter. Under the proposal, 80% of free allocation for each five-year period would be conditional on the submission, verification and approval of an investment plan.5 That converts free allowances from a passive entitlement into a performance contract. A separate benchmarks proposal is expected to provide approximately €6 billion in additional free allocation between 2026 and 2030.5
Member States would need to direct 50% of their national ETS revenues towards investments that decarbonise ETS sectors, a provision that redirects cash flows that currently fund general budgets or unrelated programmes.5
Climate commissioner Wopke Hoekstra had flagged in May (2026-05-21) that the review would bring "targeted improvements" while maintaining "stable long-term signals."1 The removals integration is structural, not targeted. And the Commission has not fully answered what happens to allowance scarcity if the cap grows by 250 million tonnes to host removals.2
The Innovation Fund and Modernisation Fund continue to support first-of-a-kind low-carbon technologies, and successful bidders under the new regime will face stricter conditions.5 The investment booster alone injects 400 million allowances into industrial decarbonisation, a supply-side move that pushes against the removals-driven demand for credits.4
The bearish case is straightforward: more supply entering the system, whether from the booster or from removal credits, delays the scarcity the market has been pricing. The bullish case rests on the conditionality attached to free allocation, which forces emitters to act or lose their allowances.5
The next forward catalyst is the EEX auction calendar. The exchange has confirmed it will stop auctioning REPowerEU carbon allowances once the €20 billion funding target is hit.3 When those auctions end, a meaningful chunk of secondary supply disappears. If that coincides with the removals integration and the booster issuance, the net effect on the ICE EUA Dec-rolling contract is genuinely unclear. The one certainty is that the ETS is no longer a pure emissions cap; it is becoming a hybrid instrument — part cap, part subsidy programme, part carbon removal market. Hybrids are harder to trade than pure signals.