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The chemical and pharmaceutical industry is fundamental to modern society. With an immense variety of products, from vital medicines and foods, the construction of buildings, to transport and leisure, the industry truly does have an impact on virtually every aspect of our daily lives.
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The EU ETS must better support industrial decarbonisation while protecting competitiveness. The chemical sector is calling for realistic emissions timelines, stronger carbon leakage protections, feasible benchmarks, market stability reforms, incentives for carbon circularity, wider ETS linking, targeted reinvestment of revenues in hard-to-abate sectors, and limits on financial speculation.
In May last year, recognising the potential benefits of creating a larger, more liquid market, and removing the competitive distortions that arise from having separate markets, the UK Government and European Union agreed to work towards linking the UK ETS and EU ETS
The UK and EU have since begun negotiations on linking our carbon pricing systems and, in December last year, both parties issued a joint statement expressing an aim to conclude talks by the time of the next UK-EU summit, this summer. In parallel to those discussions, the UK ETS Authority has continued to develop and expand the UK ETS, whilst the EU is set to kick-off a wide-ranging review of the EU ETS on the 17 July.
The UK’s (and EU’s) chemical industry remains committed to climate neutrality, but its ability to reach net zero is constrained by intense global competition, high energy and carbon costs, and an absence of key enabling conditions such as access to affordable low-carbon energy (electricity and hydrogen), a market demand for low carbon products, and effective, long-term carbon leakage mitigation measures.
Within this context, the EU ETS must evolve into a more predictable and supportive framework, that better reflects accepted industrial decarbonisation pathways, allowing European industry to remain competitive while transforming to meet our climate objectives. Without EU ETS reform, the UK and EU risk offshoring more industrial capability without any benefit to the climate.
An effective and sustainable ETS should be anchored in a clear set of principles:
1. A realistic timeline for emission reduction
2. Effective carbon leakage mitigation
3. Feasible benchmark values
4. Supportive market mechanisms
5. Promotion of carbon removals and carbon circularity
6. International growth through linking
7. Investment of revenue in decarbonisation
8. Limits on financial speculation
The CIA urges the UK Government to adopt these principles when they discuss the upcoming EU ETS review with their EU counterparts.
The EU ETS cap is set to reach zero by 2039, a trajectory now widely understood to be unrealistic. UK industry needs access to competitively priced, low carbon electricity, hydrogen and carbon capture networks to decarbonise, and the timeline for the deployment of these technologies does not match the timeline for emission reduction under the cap.
In order to avoid decarbonisation through deindustrialisation, a more pragmatic approach should be taken when setting the timeline for ETS cap decline. This approach should reflect the availability of enabling conditions including access to affordable low-carbon energy (electricity and hydrogen), carbon capture networks, markets for low carbon products, and carbon leakage mitigation measures.
The absence of an international carbon price, the uncertainty surrounding the effectiveness of the UK and EU Carbon Border Adjustment Measures (CBAMs), and the reduction of free allowances raise significant competitiveness concerns for the UK chemical industry. A high carbon price and inadequate carbon leakage mitigation expose our domestic industry to increased carbon costs, reducing the business case for (and capital needed to) invest; a situation that risks accelerating the shutdown of UK plants.
Against the current backdrop, maintaining an adequate level of free allocation and ensuring parallel compensation for indirect carbon costs remain essential pillars of effective carbon leakage mitigation. Something that the UK Government should also bear in mind in the context of the upcoming review of the EII compensation scheme this year, and the signposted review of EU benchmarks for the UK ETS.
In order for UK sites to build the business case for investment in net zero technologies, benchmark values must be achievable, reflecting actual access to energy, feedstock, technology and infrastructure. Yet for the period 2026-2030, the EU has adopted a reduction of the fallback benchmarks of 50% - the maximum rate possible in accordance with legislation - which will pose severe challenges to sites without access to low carbon heat.
The fallback benchmark has been set at such a low level because it is calculated on the basis of the 10% top performers within the fallback categories, which include sites with access to biomass, cogeneration, and heat imported from exothermal‑processes. Yet the majority of sites do not have access to these sources of heat and, without further action, will be placed at significant risk of carbon leakage.
A stable carbon price, in combination with effective carbon leakage mitigation, is required for businesses to invest in industrial decarbonisation technologies. With this in mind, the Market Stability Reserve (MSR) was established in 2018, to manage the total number of allowances in circulation, in order to help stabilise the EU carbon price.
However, in its current form, the MSR does not provide sufficient protection against upward volatility in the market, undermining the confidence businesses have to invest. The MSR needs urgent reform to handle the consequences of rapid economic changes which might limit liquidity in the market. This should be done by first returning invalidated allowances to the MSR, then halting any further invalidation. In addition, the rules governing the release of allowances should be adjusted to make them available more readily when there is upward pressure.
A robust carbon accounting system are the basis of an effective ETS. Rules in the current EU ETS circhave begun to recognise the distinctions and relative merits of varying carbon sources and sinks. However, much more needs to be done to achieve a fully circular carbon economy, in line with planetary boundaries.
As it stands, fossil carbon that is emitted must be accounted for, whereas carbon that is emitted from sustainable biomass can be ‘zero-rated’. Furthermore, where carbon is captured and buried underground (CCS), it is deemed not to have been emitted.
However, many of the products we use in our everyday lives require carbon as a key raw material and there is currently no support in the ETS for the use of non-fossil carbon feedstocks to make these products. For example, plastic made with bio-derived or captured carbon can eliminate the need for new fossil input every time it is recycled, yet the ETS confers no benefit for locking carbon into plastic.
The chemical industry would like to see a consistent and comprehensive carbon accounting system that incentivises both permanent and non-permanent carbon removals. Three changes to the EU ETS accounting rulebook would improve incentives for carbon circularity:
i. CCS with biogenic carbon or direct air capture: Permanently capturing biogenic carbon, or atmospheric carbon, should be encouraged through the award of an emission allowance within the carbon market. This could be included by either modifying the Monitoring and Reporting Regulation (MRR) (Article 49) or by reference to the Carbon Removal Certification Framework (CRCF), which already recognises the capture and storage of atmospheric and biogenic carbon as permanent carbon removal.
ii. CCU from fossil carbon: Using captured carbon to make chemicals requires us to revisit the concept of “permanently chemically bound”. The end-of-life treatment of any product is critical and, ultimately, necessitates the inclusion of the waste sector in the EU ETS. Carbon emitted at a product’s end-of-life should be accounted for in the waste sector and should not be deemed emitted by a chemical manufacturer. This would both incentivise CCU and encourage the waste sector to recirculate valuable carbon building blocks back into the economy.
iii. CCU from biogenic carbon or direct air capture: The use of biogenic carbon, or atmospheric carbon, to make chemical products should be encouraged through the award of an emission allowance within the carbon market. As per point (ii), any emissions from the products end-of-life should be accounted for in the waste sector.
In May last year, recognising the potential benefits of creating a larger, more liquid market, and removing the competitive distortions that arise from having separate markets, the UK and EU agreed to work towards linking the UK ETS and EU ETS. Further linking of the EU ETS with comparable schemes in other jurisdictions could likewise strengthen market liquidity and support cost-effective climate mitigation.
This process could be enhanced and expedited through the implementation of Article 6 of the Paris Agreement, which would allow for the introduction of international carbon credits into the EU ETS. Article 6 establishes an international framework for the trading of carbon credits and the UK and EU are both party to the Agreement. In fact, the EU has already agreed that, from 2036 onwards, 5% of the EU’s overall 2040 target could be met using Article 6 credits. Moreover, draft EU CBAM regulations propose that Article 6 credits could be used to meet up to 10% of the EU CBAM liability paid by importers to the block. Despite these moves, the use of Article 6 credits within the EU ETS remains forbidden.
The chemical industry supports the use of high-integrity Article 6 credits within the EU ETS, as a mechanism to improve medium-long term market liquidity, while emphasising the need to carefully assess the implications for industrial competitiveness and compliance cost. Notwithstanding, we recognise that the use of international credits could direct much needed investment away from UK industry, so we also call for greater investment of ETS revenue to help transition our energy intensive industries.
Auction revenues from the EU ETS amounted to €39bn in 2024, of which €2bn went to the Innovation Fund, €6bn to the Modernisation Fund and €24bn went to Member States. Whilst the Innovation Fund and Modernisation Fund already provide welcome support for the adoption of clean energy, energy efficiency and energy networks, the much larger share left to Member States should be better leveraged to crowd-in private investment in clean industrial production.
Helpfully, the EU specifies that the funds destined for Member States are spent on climate and energy policy, however ‘climate and energy policy’ can cover a broad range of investments, including energy transformation, adaptation, decarbonisation of transport and actions to support a just transition. In order to ensure the European industrial ecosystem can remain competitive as it invests in clean technology, an explicit direction to invest in hard-to-abate, ETS-covered sectors is needed. In the context of linking the UK and EU schemes, this requirement should extend to revenue from the UK scheme.
The trading of allowances is an important part of the ETS design. The cost of cutting emissions varies across businesses; Some participants are able to reduce their emissions in the near-term, whereas others face high abatement costs and must await enabling conditions like hydrogen supply or low cost electricity. Trading allows those with lower cost reductions to sell excess allowances to those who cannot make immediate cuts. The emissions cap is met but society pays less by allowing the market to find the most cost-efficient reductions.
However, rules governing who can trade in the EU carbon market are interfering with this market dynamic, artificially driving up the cost to EU ETS participants at a time when European industry is struggling to maintain international competitiveness. The EU ETS Registry permits non‑ETS participants to hold and trade allowances, meaning banks, traders, financial institutions, and others can buy and sell emission allowances for financial gain. Speculation in the market not only drives up compliance costs for industry, it drives up the cost of electricity too because of the way carbon pricing affects the power sector. The EU should move to limit speculation in the carbon market, returning it to its original principles.
The EU ETS remains a cornerstone of climate policy, but its long-term success depends on supporting industrial transformation, as well as emissions reduction. By adopting these principles, the UK and EU can strengthen competitiveness, safeguard strategic industrial capacity, and deliver a credible, investment-led pathway to climate neutrality. With the right policies in place, Europe’s chemical sector can become an engine of growth within a clean and circular economy.
CIA warns that unchecked financial speculation in the UK carbon market is distorting allowance prices, driving up compliance and electricity costs, and undermining the competitiveness of UK manufacturing. As the UK negotiates ETS linking with the EU, restricting speculative trading is essential to restore the cap‑and‑trade system’s core ...
