Will the EU & UK ETS decarbonize industry and drive demand for CDR?

Taxpayers will need to spend more than we are preparing for.

The EU & UK ETS are the most important climate policy instruments in Europe, and many hope they can both decarbonize heavy industry and create a major market for carbon removal. But that assumption rests on conditions that may not hold. What would it actually take for the ETS to drive deep industrial cuts and significant CDR demand? And how likely is that outcome?

The EU’s climate architecture is split across three systems: ETS I, the original emissions trading scheme covering power, industry, and intra-EU aviation and shipping; ETS2, a parallel cap-and-trade for buildings and road transport starting in 2027; and the Effort Sharing Regulation, which sets national targets for the remaining sectors outside both ETS systems. Most (if not all) EU market-based CDR demand is expected to come from expensive-to-abate industrial sectors in ETS I. The UK ETS, which mirrors the scope of ETS I, would create demand in the same types of sectors for the same underlying reasons.

Approximate size of the systems

There are only three ways a country or jurisdiction, such as the EU, could reach net zero for expensive-to-abate emissions:

1) A majority of its trading partners implement as ambitious climate policy for industrial emitters, leveling competition so that industries can pay.
2) The green premium falls radically, so expensive-to-abate emissions aren’t expensive anymore (unlikely), OR
3) Taxpayers directly fund the transition; through contracts for difference, capex support, carbon removal purchases, and/or clean-demand mandates that push the cost downstream to consumers.¹

Any one of these, or a mix of all three, could deliver net zero for heavy industry. What is not sufficient on its own is an emission trading system or carbon tax.

Why ETS alone cannot carry heavy industry decarbonization

Energy-intensive industries such as steel, cement, and chemicals operate on single-digit margins. A high enough carbon, or ETS price (above €100/t) to incentivize the transition would more than wipe out profits. In the EU, most of these sectors already receive free allowances for all of their ETS emissions and still struggle to stay globally competitive.

This is why the EU has introduced a Carbon Border Adjustment Mechanism (CBAM), and why the UK is preparing to introduce a similar mechanism. A functioning CBAM would make industries in other countries face the same climate costs as European industries, at least for the part of production they export to Europe. That is pathway (1) in practice: force some convergence on climate costs at the border.

However, there is a big risk that the CBAM will be insufficient to ensure competitiveness as it; a) protects European producers on the import side, but does nothing for their exports, which face global competition with no carbon price, and b) are at risk of being gamed through “equivalent measures” for example, through countries outside the EU implementing their own carbon tax but indirectly channeling the revenue back to their exposed industries.

If the CBAM doesn’t work as intended, the EU ETS is very unlikely to be a tool for reaching net zero for heavy industry. Rather than let their industries go bankrupt, the EU would pause the phaseout of allowances, keeping ETS prices low.

In reality, option (3): public money and demand mandates are needed on top of the ETS. We already see this happening. There is a massive rollout of contracts for differences in UK, Germany, France, Netherlands for things like green steel, ammonia, and cement-CCS. But these are typically for pilot facilities. I don’t think decision makers are ready for the scale of state support needed for EU heavy industry to reach net zero significantly earlier than the rest of the world if the CBAM is not effective enough.

We see examples of what happens when the state won’t pay. For example, Heidelberg Cement is cancelling its plans for a CCS installation at its Slite plant, which provides 70% of Sweden’s cement, due to the lack of financial support from the Swedish government.

Measures that force clean demand are also part of the solution. ReFuel EU and FuelEU Maritime are examples of this, forcing aviators and shippers to buy clean fuel. Similar quotas could be extended to other sectors, for example, an increasing amount, and finally, only zero-emission steel and cement could be allowed to be sold in the Union. (Clean Air Task Force just published an excellent brief on this topic.)

These are all variants of pathway (3): use public money and regulatory mandates to make someone other than heavy emitters pay the green premium so industry survives the transition.

Where does CDR fit in the ETS picture?

The hope for CDR demand in the EU ETS I is that CBAM works well and the ETS allowance phase-out trajectory holds. In that case, CDR can play a significant part for heavy industry. If no allowances exist, CDR will be the only option for those who still have emissions. CDR also introduces a ceiling in the ETS; prices will not rise higher than the cost of removals entering the system.

In the event CBAM doesn’t work well, a weakened ETS I will neither lead to net zero or drive much demand for CDR. Hard-to-abate companies can’t afford CDR any more than they can afford decarbonizing, and sectors that are not expensive-to-abate (like power) mostly have cheaper options than CDR.

Another complicating factor is that European CDR costs are likely to be high. Even if the CBAM works, CDR prices in the EU is probably going to be well above €200/t, maybe even +€300/t. Since the EU commission seems set on only including EU CRCF-certified removals into the ETS, this may mean that CDR may have a hard time competing with alternative solutions.

• Biochar in Europe faces high labour, permitting, and biomass costs, with limited ability to subsidise via physical biochar sales at large scales.

• Enhanced rock weathering is less effective in winter, and many soils in the EU are unsuitable for weathering. keeping ERW prices higher.

• DACCS in the EU will suffer from high EU electricity prices, and/or costly transport of the CO₂ ; seeing DAC below ~€250/t in Europe is hard in any foreseeable future.

• BECCS today is priced around €350–400/t without subsidies, with limited ability to bring prices radically down due to each installation being unique. (At least on larger heat and power plants and pulp and paper mills, biogas CO₂ separation and storage have a clearer path to lower costs.)

• Biomass direct storage may evolve to a cheaper method, but there is uncertainty about its permanence, and currently its’s not part of CRCF discussions.

For most ETS-covered installations, adding carbon capture and storage (CCS) or redesigning the process will be cheaper than paying €200–300/t for removals. CDR would only be used for a small sliver of residual emissions where CCS is technically impossible or blocked, and where all other solutions are even more expensive than CDR. The same logic would apply to the UK ETS.

This is explored by Sultani et al (2024) which model CDR integration into ETS I. At CDR prices around €300/t their model estimates roughly 60 Mt/yr of ETS-driven CDR demand in 2050, and at CDR costs of €250/t about 120–130 Mt/yr. Industry and aviation are the remaining emissions using CDR in the model.

However, even when CCS is cheaper in theory, CDR introduces some optionality; retrofitting a cement kiln or steel plant with CCS is a massive capex undertaking, and it also takes about a decade from start to finish. Buying CDR allowances on a market could be a temporary rational measure even for those that eventually choose CCS.

Even if CDR became cheap (e.g., <$150/t) in the EU, or if international CDR credits were allowed, ETS wouldn’t drive CDR demand in the short to medium term (early 2030s). This is because ETS allowance prices are lower than even cheap CDR levels. The UK is introducing contracts for differences for CDR integration into the ETS to counter this, and the EU could do something similar. This means some CDR credits would enter the ETS, with the difference from the allowance price and CDR price paid for by the government. This is not a subsidy everyone can use; it is only for projects that win government contracts.

Another blocker for the CDR in the EU ETS is that the otherwise most likely sectors for buying carbon removal, Aviation and Shipping, are effectively forced to choose clean fuels through the ReFuel EU and FuelEU Maritime directives, and therefore won’t be buyers of CDR in the ETS with the current regulation. (Read more about this issue in here.) The UK may choose differently, and its recent GGR report recommended letting CDR compete with SAF for aviation.

Another source of emissions is the EU ETS2 covering transport, buildings and rest of manufacturing. CDR could be the cheapest option for some of these emissions too, especially building energy use, at least temporarily. But ETS 2 does not have the same phase-out trajectory as ETS I, and there are mechanisms to keep the allowance costs down. For political reasons, it is unlikely that allowance prices in the ETS 2 will ever rise high enough to incentivize CDR, which means governments would need to pay for CDR to counterbalance whatever is left if net zero is to be reached.

The third large source of emissions in the EU is the Effort Sharing Regulation (ESR), which covers about a gigaton of (mostly non-CO₂) emissions from agriculture, waste, industrial process & product use not in ETS I, and remaining small combustion / off-road, etc., not in the ETS2 baseline. Here, quite a few residual emissions are expected, but there is no market-based mechanism to deal with them. The ESR also has no cap or mandatory pathway to zero. Member states would need to procure the CDR needed to counterbalance the remaining CO₂ emissions here as well.

To me, it seems likely that taxpayers will have to pick up most of the bill for both heavy industry decarbonization and wider CDR use. If you want to reach net zero well ahead of the rest of the world, you are likely to have to pay for it.

The cost, however, is not big on a societal level. Zero-carbon steel and cement can for example be nearly twice as expensive to produce, which can kill a supplier, but the price of the end products is hardly affected: a building or car with zero emission inputs costs only a few percent more. Compared to member states’ budgets, the cost of decarbonization and neutralization with CDR is also small. As an example, 500 Mt of CDR would cost €100 billion at €200/t, around 1.4% of EU member states’ tax revenue.

To summarize, the EU ETS I will not generate much demand for CDR unless the CBAM works flawlessly. If CBAM underperforms (a high risk), the ETS will be politically constrained, and industrial emissions will never face the carbon prices needed to drive either deep decarbonization or large-scale removals. Even in the optimistic case where the EU CBAM holds, ETS-driven CDR demand in both the EU and UK is likely to remain limited to a relatively thin slice of emissions where European CDR is cost-competitive. Taxpayers, not heavy emitters, will likely have to pay for most carbon removal needed to reach net zero. The good news is that society can afford it. The cost that bankrupts one sector is marginal for the whole economy. Whether Europe is politically willing to do that is the real question.

1. Of course, taxpayers and consumers always pays. Even if the entire world had the same climate policy and there was no need for state support or clean demand mandates, the green premium would not go away but would be spread on top of products. The difference here is that direct payment is needed, or mandates that force demand through quotas or similar, and that only EU taxpayers and consumers are hit with the cost.