A single year of fossil fuel price disruption comparable to the recent Strait of Hormuz closure would cost Europe’s steel, cement, and organic chemical sectors more than €17 billion in additional expenses relative to a decarbonised production pathway.
That figure, drawn from joint modelling by Agora Industry with the Wuppertal Institute and University of Kassel, provides the most concrete quantification yet of what sustained fossil dependence costs European heavy industry in shock scenarios that are no longer hypothetical. The same modelling finds that the transition to domestic renewable electricity, hydrogen, and sustainable biomass would cost less than one percent of European industrial gross value added annually. The economics of the transformation are defensible. What remains unresolved is whether the EU Emissions Trading System, the primary policy instrument intended to drive that transformation, will be reformed in a way that supports it or undermines it.
The ETS reform proposal from the European Commission, expected in the coming months, arrives at a moment when the carbon price signal that the system is designed to deliver has been persistently contested. EU ETS carbon prices fell from highs above €100 per tonne in 2023 to below €60 per tonne through much of 2024 and 2025, a decline that reduces the financial incentive for capital-intensive decarbonisation investments precisely when those investments need to be committed. Steel plants converting to direct reduced iron technology, cement producers installing carbon capture, and chemical manufacturers shifting from naphtha to biomass feedstocks are all making 20-to-30-year capital decisions against a carbon price signal that has moved in the wrong direction.
What the Agora Analysis Says About ETS Design
The companion paper by Agora Energiewende on ETS design identifies three structural parameters whose treatment in the reform will determine whether the carbon market continues to drive industrial decarbonisation or accommodates continued fossil investment. The first is the linear reduction factor, currently set at 4.4% per year, which governs how quickly the total volume of emission allowances in the system declines annually. Agora Energiewende argues that maintaining this rate until 2035 is essential to provide investment certainty for companies that have already committed to climate-neutral production or are in the process of doing so. A reduction in the LRF before 2035 would send an unambiguous signal that the carbon price trajectory is being softened under industrial pressure, undermining exactly the forward price expectations that make long-lived decarbonisation investments bankable.
After 2035, the modelling finds that the LRF can be reduced to 2% while remaining consistent with the emissions trajectory required to reach 68 million tonnes of CO2 from steel, cement, and organic chemicals by 2040, down from current levels that are substantially higher. That pathway would place the ETS cap at 200 million tonnes in 2040, though the actual supply of emission certificates in circulation also reflects disbursements from the Market Stability Reserve, negative emissions accounting, and other reserve mechanisms that need to be managed jointly rather than in isolation.
The Market Stability Reserve is the second structural parameter. As the emissions cap declines over time, the MSR’s role in managing residual allowance supply becomes increasingly important. A system with a shrinking cap but inadequate MSR rules can produce either chronic oversupply, which collapses the carbon price, or chronic scarcity, which pushes prices beyond what industrialists can plan around. The Agora ETS paper calls for the MSR to remain strictly rule-based with quantitative parameters, a design principle that guards against discretionary interventions that would reintroduce political uncertainty into what should be a market-driven price signal.
The Free Allocation Problem and What Reform Must Address
The third and most contentious structural parameter is free allocation, the practice of providing industrial emitters with a portion of their allowances without charge to offset carbon leakage risk. Free allocation is currently scheduled to be phased out in sectors covered by the Carbon Border Adjustment Mechanism by 2034, as CBAM takes over the leakage protection function through border charges on carbon-intensive imports. The Agora analysis argues that in any instances where free allocation continues beyond that phase-out, it must be strictly linked to investments in decarbonising European production sites.
This conditionality argument has significant implications for how the reform is designed operationally. An unconditional free allocation is effectively a subsidy to incumbents for continuing their existing production methods, because it reduces the cost of maintaining fossil-based assets without requiring any capital commitment toward their replacement. A conditional allocation, by contrast, makes the subsidy contingent on verified capital expenditure toward decarbonisation, transforming it from a protection against competitive disadvantage into an investment incentive. The Agora paper argues that this redesign would allow the ETS to reward companies that modernise their assets while reducing carbon leakage risk and securing local employment, outcomes that unconditional allocation cannot deliver.
CBAM’s Role and Its Limits
CBAM entered its implementation phase in 2026, applying financial adjustments to imports of steel, aluminium, cement, fertilisers, hydrogen, and electricity based on their embedded carbon content. Its expansion to additional sectors is scheduled for subsequent review cycles. For European heavy industry, CBAM protects the domestic market against competition from producers in jurisdictions without equivalent carbon costs, which addresses the carbon leakage concern that has historically been used to justify free allocation.
The protection CBAM provides has two structural limits that the ETS reform cannot fully compensate for. First, CBAM covers imports into the EU but provides no relief for European exporters competing in third markets. A European steel producer selling into Asian or North American markets faces the full cost of the EU carbon price in its production cost structure while competing against producers bearing no equivalent cost. This export competitiveness problem is one the ETS alone cannot resolve, and the Agora analysis’s framing of industrial decarbonisation as a route to competing in the “rapidly expanding global green market” is partly an argument that green product demand premiums in export markets will eventually offset this disadvantage, a claim that depends on green procurement policies in third countries materialising faster than is currently visible.
Second, CBAM’s effectiveness depends on the accuracy and verifiability of embedded carbon calculations for imports. If trading partners can successfully argue that their production processes embed less carbon than European regulators calculate, or if verification mechanisms are inadequate, the border adjustment underprotects European producers. The administrative architecture of CBAM verification is still being constructed, and its robustness will only become apparent as the first full cycles of financial adjustment are implemented and challenged.
Infrastructure as the Binding Constraint
Both the Agora Industry and Agora Energiewende papers conclude that ETS and CBAM reform must be embedded within a comprehensive industrial policy that accelerates infrastructure expansion. Industrial electricity demand is projected to more than triple to almost 380 TWh per year by 2050 under the Increased Resource Sovereignty scenario, a volume that requires both renewable generation capacity and high-capacity grid connections to industrial sites that do not currently exist at the required scale. Green hydrogen demand from steel and chemicals reaches almost 80 TWh annually under the same scenario, requiring electrolyser deployment and hydrogen pipeline infrastructure that is still in early planning stages across most of the EU.
The investment vehicles proposed to channel ETS revenues toward these infrastructure needs, specifically the Investment Booster and the proposed Industrial Decarbonisation Bank, remain at framework stage rather than operational reality. ETS revenues collected from covered sectors amounted to approximately €38 billion in 2024, a significant capital pool that the Agora papers argue should be directed toward industrial decarbonisation rather than dispersed across general climate and social funds. Whether the Commission’s reform proposal will establish a sufficiently targeted allocation mechanism for these revenues is one of the practical questions whose answer will determine whether the ETS functions as the investment driver the analysis requires it to be.
