Carbon credits and the EU ETS review: the key battles ahead

Introduction

The European Commission has unveiled its proposed overhaul of the EU Emissions Trading System (ETS). The package has the potential to reshape Europe’s flagship climate policy, but also has significant implications for the global market for project-based carbon credits.

Mainstream attention will understandably focus on the ETS itself: the proposed adjustment to the linear reduction factor (LRF) and changes to the system’s scope. The trajectory of the ETS cap determines how quickly emissions from covered sectors must fall, while its scope determines which activities face a carbon price. Together, the proposals announced today would make the post-2030 decarbonisation pathway more gradual to ease pressure on European industry, while extending the ETS to new sectors including some outbound flights.

For the project-based carbon markets, the focus of this report, several developments stand out:

• The Commission is proposing to bring both domestic carbon removals and international Article 6 credits into the ETS policy toolkit.

• They do not propose a direct integration model for credits in the ETS (at least in the immediate term). Rather, they propose procurement by a central agency funded via the auction of allowances.

• On CORSIA, the Commission does not propose immediate restrictions on the credits EU airlines can use, despite publishing a highly critical assessment of the scheme’s environmental integrity. Instead, it proposes extending the ETS from 2029 to cover certain outbound flights to destinations within 5,000 kilometres of the EU.

Crucially, these are proposals, not settled policy. The European Parliament and Council will now scrutinise the package, develop their own positions and negotiate the final legislation with the Commission. Important questions therefore remain open for debate. Further technical rules are also likely to be developed through subsequent delegated and implementing acts. The process will take time, and the final framework could look materially different from the Commission’s opening position.

In this piece, we examine the key elements of the review affecting project-based carbon credits, identify the main fault lines in the negotiations ahead, and set out where policymakers should focus to strengthen the proposals.

1. Domestic removals

The Commission’s proposal:

The Commission proposes to integrate up to 250 million tonnes of domestic permanent carbon removals into the ETS between 2031 and 2040. Procurement would be funded through the auctioning of allowances and initially limited to EU CRCF-certified BECCS and DACCS removals. Other technology-based removal pathways, including biochar, would not be eligible under the proposed initial model.

The Commission would purchase the units centrally, as discussed further in Section 3, prioritising a cost-effective, high-integrity portfolio and paying upon delivery. There is one limited route for direct use: ETS operators could use CRCF-certified BECCS removals that they generate themselves.

By the end of 2034, the Commission would report on whether domestic nature-based removals could contribute to the ETS, and whether the system could transition towards wider direct use by ETS operators. Notably, the proposed review point does not explicitly provide a route for biochar and other non-geological technology-based removal pathways.

BeZero’s view:

Overall, we strongly welcome the integration of domestic removals into the ETS. The Commission is explicitly recognising that high-integrity removals can provide a credible complement to emissions reductions. Up to 250 million tonnes of demand over a decade would also provide a powerful signal to European removal developers and investors.

However, restricting eligibility to BECCS and DACCS risks undermining the Commission’s cost-efficiency objective. These removal types currently cost substantially more than EU allowances, while other technology-based and nature-based pathways could potentially deliver removals more cheaply and at greater scale.

There is an understandable rationale behind the Commission’s thinking, based on the greater carbon accounting uncertainty and permanence risks associated with non-geological removals. However, as we argued in our recent UK ETS paper, there are a range of mechanisms that could be applied to overcome these barriers. Risk-adjusted crediting, independent ongoing monitoring, actively managed portfolios, permanence funds and insurance mechanisms can support the credible inclusion of a broader range of pathways.

The proposed 2034 review point is too little, too late. The scope should be broadened to consider all possible removal pathways sooner. Solutions already exist today to manage risk effectively and, with political will, pilot programmes and regulatory sandboxes could be rapidly established to explore these solutions. With billions of euros at stake for European industry and taxpayers, these options should be tested now.

2. International credits

The Commission’s proposal:

The Commission proposes to procure up to 260 million tonnes of high-integrity international credits between 2036 and 2040. This represents the ETS share of the EU’s wider international-credit flexibility: as ETS sectors account for around 40% of EU emissions, they are allocated around 2 percentage points of the economy-wide 5% allowance.

As with domestic removals, procurement would be funded through allowance auctions and managed by a central body, rather than by compliance entities themselves. If sufficient high-integrity, cost-effective international credits are unavailable, the ETS linear reduction factor would revert to a higher level.

The Commission would report by January 2033 on the availability, integrity and potential ETS implications of international credits. The detailed eligibility rules and safeguards have not yet been established and will require separate EU legislation.

BeZero’s view:

As above, the direction of travel is positive. The proposal recognises that high-integrity international credits can reduce the cost of meeting Europe’s climate targets while directing finance towards mitigation in partner countries. The remaining 3 percentage points of the 5% allowance should be used to meet national targets and non-ETS sector targets, applying consistent integrity criteria and transparent reporting.

The EU should use the permitted 2031–2035 pilot period for international credits to make real purchases - not commission a feasibility study. The pilot should test procurement, delivery and integrity-risk management in practice, drawing on established market service providers. The credits should also have a clearly defined use case, ensuring the exercise tests the full system from purchase to retirement.

As we argued in detail in our paper International carbon credits in the EU 2040 target: A blueprint for environmental integrity, the EU should resist imposing blanket exclusions on particular project types. As the Commission highlights itself in its criticism of CORSIA (see below), credit performance risk varies significantly between projects operating under the same methodology or within the same sector. Sector-level exclusions risk constraining the EU’s optionality in areas where the delivery of high integrity credits is not just possible, but proven. Eligibility should therefore combine robust minimum standards with project-level assessment, as discussed further below.

3. A central purchasing body for carbon credits

The Commission’s proposal:

Neither the domestic removals programme nor the international credit facility would be based on direct use by ETS entities (with a limited exception for BECCS discussed above). Instead, the Commission would auction allowances and use the proceeds to purchase credits centrally. The credits would sit “above the cap”: they would be cancelled/retired centrally, while compliance entities continue to trade and surrender EU allowances as they currently do.

The detailed design remains open. For domestic removals, this will be defined via delegated acts and for international credits, further legislation will be required.

BeZero’s view:

Central purchasing has advantages, particularly during the early stages of integration. It allows the EU to control volumes, manage the price differential between credits and allowances and set a high standard for environmental integrity, including via assessment at the project-level. This reflects an important lesson from the Clean Development Mechanism (CDM) era: approval under a methodology or standard does not mean every credit carries the same level of risk.

But centralisation also creates a significant risk of bureaucracy, delay and false confidence in a bespoke EU process. The Commission should not attempt to recreate from scratch the infrastructure that the project-based carbon market has spent years developing.

Methodologies and programme-level eligibility provide an important first screen, but they cannot capture nuanced differences in project design, baseline assumptions, additionality, leakage, carbon accounting quantification, permanence risk or on-the-ground implementation. The purchasing body will therefore need a project-level due-diligence framework. This should draw on established market infrastructure, including independent ratings.

Using carbon ratings would not replace the Commission’s eligibility rules or procurement decisions. It would provide a consistent and transparent assessment of the risk that individual credits fail to deliver their claimed carbon outcome (and one that we expect to soon be backed by ESMA regulation). This distinction is critical: programme eligibility answers whether a credit may be considered for purchase while project-level assessment helps determine whether it should be purchased and at what price.

The facility will also need arrangements for ongoing monitoring rather than relying solely on an assessment at the point of purchase. Procurement rules should address underperformance, reversals and new information emerging after contracting. This information can be provided via ratings-based monitoring. Transparency over project selection, prices and portfolio-level risk will be essential if the Commission is spending billions of euros.

Central purchasing may be sensible initially, but it should not necessarily become permanent. Once integrity safeguards and market infrastructure are established, the EU should consider a controlled transition towards greater direct participation by ETS entities. This could improve competition, reduce administrative burdens and allow the market to allocate capital more efficiently while the Commission retains strong eligibility, disclosure and oversight rules.

4. Aviation emissions and CORSIA

The Commission’s proposal:

The Commission has concluded that CORSIA has not been strengthened sufficiently and that participating states account for less than 70% of international aviation emissions. Nevertheless, it has stopped short of imposing immediate additional restrictions on the CORSIA credits that EU airlines can use.

Instead, the proposal would continue the current “stop-the-clock” limitation of the aviation ETS through 2028. From 2029 to 2032, the ETS would expand to cover certain flights departing the EEA for destinations within approximately 5,000 kilometres. This targeted approach largely avoids routes to major aviation markets such as the US, China and India. Airlines would be able to deduct eligible CORSIA costs from their ETS obligations to avoid double payment.

The Commission would review CORSIA again in 2032. If it has become sufficiently ambitious and participation has exceeded 70% of international aviation emissions, the EU could return to a narrower aviation ETS scope.

BeZero’s view:

The Commission’s assessment confirms what BeZero ratings have shown for some time: CORSIA eligibility alone is no guarantee of environmental integrity. Credits approved for use under the scheme can carry materially different levels of risk, and the absence of systematic project-level assessment is a fundamental weakness.

The decision not to impose immediate restrictions on the credits that can be used by EU airlines will reassure airlines, traders and project developers. But it must not become a licence for complacency. Higher-integrity CORSIA credits are already available, with more expected to enter the market, and airlines cannot credibly claim ignorance of the differences between eligible projects.

The Commission has chosen to respond to CORSIA’s weaknesses primarily by expanding the geographical reach of the EU ETS, rather than by immediately strengthening the rules governing which credits EU airlines may use. That approach risks increasing geopolitical tensions while leaving the underlying credit integrity problem unresolved.

A more effective response would be to supplement CORSIA’s programme-level rules with transparent project-level due diligence. Airlines should be expected to assess and disclose the risks associated with the credits they purchase, using independent analysis such as ratings where appropriate. The EU could make this a requirement for its domiciled airlines and/or could argue for this at a scheme-level via its engagement with ICAO. This would preserve CORSIA as the global mechanism to tackle international aviation emissions while creating a stronger commercial incentive for higher-integrity projects.