Climate change and the progressive rise in global temperatures represent one of the most significant long-term challenges facing contemporary economic systems and societies. The scientific evidence accumulated over recent decades has progressively reinforced the need for rapid, coordinated action to reduce greenhouse gas emissions and accelerate the transition to lower-carbon production and consumption models. In this context, climate science and related technical disciplines remain essential in defining the scale, urgency and potential consequences of global warming, while contributing to the identification of transition pathways compatible with long-term environmental sustainability objectives.
Within this broader framework, economic analysis performs a different, though complementary, function. Economics does not determine the existence or relevance of climate risk; rather, it focuses on the mechanisms by which scarce resources, investment incentives and industrial transformation processes are organised to pursue collective environmental objectives under conditions of structural economic constraints. This dimension becomes particularly relevant in the context of climate-transition policies, which require the mobilisation of exceptionally large volumes of public and private capital over extended time horizons while simultaneously preserving industrial competitiveness, energy-system stability, technological feasibility and broader economic resilience. The European decarbonisation pathway increasingly relies on a combination of carbon pricing, regulatory intervention, industrial policy, infrastructure deployment and public support mechanisms intended to accelerate technological transformation and guide long-term investment decisions. According to recent European Commission assessments, the scale of investment required to support the transition during the 2031–2040 period is expected to exceed EUR 1.5 trillion annually at the EU level. Under these conditions, the effectiveness, coherence, and long-term sustainability of the economic mechanisms adopted to support decarbonisation become matters of legitimate analytical and policy relevance.
The present research is therefore grounded in the assumption that evaluating the functioning of climate-related economic instruments does not imply questioning the legitimacy of climate objectives themselves. On the contrary, precisely because decarbonisation constitutes a strategic public-interest objective requiring the mobilisation of substantial economic and financial resources, it becomes increasingly important to assess whether the institutional and market frameworks supporting the transition remain capable of allocating such resources efficiently, proportionately and consistently over time. In this perspective, the study adopts an evidence-based, system-oriented approach to examine the interaction among carbon pricing, electricity markets, industrial transformation, financial-market dynamics, and long-term investment conditions within the evolving European regulatory framework. The objective is not to challenge the necessity of rapid climate action, but rather to contribute to broader reflection on how the economic architecture of the transition may evolve to preserve environmental effectiveness while strengthening industrial feasibility, investment sustainability and long-term economic coherence across the European decarbonisation pathway.
THE ETS AS A MARKET-BASED INSTRUMENT AND ITA EVOLVING GOVERNANCE
Since its introduction, the European Union Emissions Trading System (EU ETS) has represented one of the most advanced applications of a market-based environmental policy instrument within a large integrated economic area. Its underlying economic rationale is grounded in the principle that the pricing of carbon emissions can internalise environmental externalities and guide economic agents towards lower-emission production and investment choices through decentralised market signals. Within this framework, the carbon price is intended to coordinate operational and long-term investment decisions while preserving technological neutrality and allowing economic actors to identify decarbonisation pathways according to relative costs, technological availability and sector-specific conditions.
Under its original conceptual architecture, the effectiveness of the ETS was therefore closely linked to the capacity of the carbon-price signal to influence production, consumption and investment decisions across sectors over time. The gradual tightening of the emissions cap, combined with intertemporal optimisation and allowance banking, was designed to create an increasingly binding scarcity framework that supports long-term decarbonisation incentives while maintaining flexibility in allocating abatement efforts. However, the progressive evolution of the European climate policy framework has increasingly transformed the broader context in which the ETS operates. Over time, the European decarbonisation architecture has progressively incorporated a wider range of industrial policy instruments, public support mechanisms, infrastructure planning frameworks and strategic transition objectives, extending beyond the original logic of a stand-alone carbon pricing mechanism. Industrial resilience, energy security, strategic autonomy, infrastructure deployment, permitting acceleration, supply-chain protection and manufacturing-capacity preservation increasingly interact with the functioning of carbon pricing itself. Recent initiatives such as the Industrial Accelerator Act further reinforce this broader policy direction by explicitly linking industrial decarbonisation with strategic manufacturing capacity, economic security and “Made in EU” objectives.
At the same time, the governance of the ETS itself has progressively evolved beyond a purely passive cap-and-trade structure. The introduction of mechanisms such as the Market Stability Reserve (MSR), together with recurring policy debates concerning carbon-price volatility, industrial competitiveness, free allocation, indirect compensation and transition financing, has contributed to a progressively more articulated governance environment in which market coordination increasingly interacts with broader policy-intervention objectives. In parallel, the expansion of derivatives markets, intertemporal banking and forward carbon trading has increasingly transformed the economic nature of the ETS itself. In a fully bankable and forward-looking carbon market, EUA prices no longer reflect only contemporaneous emissions scarcity, but also expectations regarding future regulatory tightening, hedging demand, liquidity conditions, intermediary positioning and broader financial-market dynamics.
Under these conditions, the carbon price progressively evolves beyond a purely environmental compliance signal and increasingly acquires the characteristics of a strategic intertemporal asset price embedded within wider financial, industrial and regulatory expectations. This evolution does not necessarily imply market malfunctioning. However, it raises increasingly relevant questions concerning the relationship between financialised carbon-price formation, real-economy adjustment capacity, industrial transition feasibility and the original environmental rationale of the ETS framework itself. At the same time, the practical effectiveness of the ETS increasingly depends on its interaction with a broader set of economic and institutional conditions extending beyond carbon scarcity alone. Electricity-market design, renewable-remuneration mechanisms, industrial competitiveness, infrastructure availability, technological readiness, long-term financing conditions and public-support frameworks increasingly influence how carbon-price signals are transmitted into real-economy investment and decarbonisation dynamics.
Within this evolving framework, the relationship between market-based coordination and public policy intervention becomes analytically central. The coexistence of carbon pricing with increasingly articulated industrial, financial and technological policy frameworks does not invalidate the economic rationale of the ETS. However, it raises increasingly important questions concerning the coherence of incentives, the interaction between overlapping policy instruments and the extent to which carbon pricing continues to operate as an efficient and interpretable driver of long-term industrial and energy-system transformation.
The present research is developed within this broader perspective. It does not question the theoretical legitimacy of carbon pricing as an instrument for addressing environmental externalities, nor the strategic importance of European decarbonisation objectives. Rather, it investigates how the functioning of the ETS evolves when operating within an increasingly hybrid governance architecture combining carbon pricing, industrial policy, electricity-market design, financial-market structures, public intervention mechanisms and long-term transition-planning objectives.
RESEARCH OBJECTIVE AND METHODOLOGICAL POSITIONING
Against this background, the objective of the present research is to contribute to a broader evidence-based assessment of the evolving interactions among carbon pricing, electricity-market dynamics, industrial transformation, financial-market structures and long-term transition-investment requirements within the European climate-policy framework. The study does not seek to provide a normative or ideological interpretation of the ETS, nor to formulate deterministic conclusions regarding the future evolution of the European decarbonisation pathway. Rather, it aims to examine, through different analytical perspectives, whether some structural features emerging from the current functioning of the system may generate tensions, asymmetries or coordination challenges potentially relevant for future policy evaluation and reform discussions.
The research was developed within a collaborative framework involving the Centre for Research in Economics and Regulation of Industry, Services and Public Sector (CESISP), at the University of Milano-Bicocca, and several industrial associations representing ETS-covered sectors. The objective of the work is not to support predefined policy positions, but rather to contribute to a more informed understanding of the economic mechanisms operating within the ETS architecture and of their interaction with the broader industrial and energy transition process. The analytical framework combines descriptive analysis, econometric modelling, market-data interpretation and institutional assessment across multiple dimensions of the European carbon system. Particular attention is devoted to the interaction between theoretical market design and the actual economic transmission mechanisms observed in practice. In this respect, the research adopts a systemic perspective, recognising that the functioning of the ETS can no longer be assessed in isolation from the wider regulatory, industrial and financial environment in which it operates. Electricity-market structures, financial intermediation, infrastructure availability, industrial competitiveness, technological readiness, public-support mechanisms and long-term investment conditions increasingly interact with carbon-pricing dynamics. They may materially influence the effectiveness, proportionality and long-term sustainability of the broader transition framework. Several chapters of the research, therefore, focus on the direct effects of carbon pricing itself, and on the interaction between ETS-related incentives and the surrounding economic architecture through which decarbonisation signals are transmitted into investment decisions, industrial adjustment and electricity-market outcomes.
STRUCTURE OF THE REPORT
The research is structured around five main areas of analysis, each addressing a specific dimension of the ETS’s functioning and its interaction with the broader European industrial, financial and energy-transition framework. While each chapter develops an autonomous analytical perspective, the overall structure of the study follows a common underlying objective: assessing how the evolving ETS architecture interacts with real economic systems, electricity-market dynamics, industrial transformation processes, financial-market structures and long-term investment conditions under increasingly complex transition scenarios.
The first chapter examines the relationship between the ETS price signal and electricity-market functioning, with particular attention to the transmission of carbon costs into wholesale electricity prices and the generation of ETS-related inframarginal revenues within low-carbon generation technologies. Through an empirical framework combining electricity-market data, generation structures and econometric analysis, the chapter investigates whether the ETS effectively operates primarily through autonomous renewable-investment incentives or through electricity-price formation, carbon-cost pass-through dynamics and revenue-redistribution mechanisms within the power sector. Particular attention is devoted to the interaction between ETS-related price effects, renewable-support mechanisms, electricity-market design and indirect ETS cost compensation frameworks.
The second chapter focuses on the manufacturing sector and analyses the evolution of industrial installations, verified emissions and industrial adjustment dynamics across the main ETS-covered sectors within the European Union. Beyond the descriptive assessment of sectoral trends, the analysis investigates the extent to which observed industrial ETS performance reflects not only endogenous firm-level efficiency, but also broader exogenous structural conditions linked to electricity systems, infrastructure availability, technological readiness, industrial competitiveness and access to decarbonised industrial inputs across Member States. e third chapter addresses the functioning of the primary and secondary carbon markets, with particular focus on derivatives markets, financial positioning and forward price-formation dynamics within the ETS. The analysis explores the growing roles of financial intermediation, expectations, hedging demand and forward-market structures in shaping carbon-price dynamics, thereby contributing to a broader reflection on the evolving relationship between regulated scarcity, market liquidity, intertemporal optimisation and financial-market participation within the European carbon system.
The fourth chapter examines the allocation framework and benchmark mechanisms governing industrial free allocation within the ETS. Using plant-level and sectoral evidence, the chapter investigates the extent to which the current allocation structure reflects heterogeneous technological, infrastructural and energy-system conditions across industrial sectors and Member States. Particular attention is devoted to the interaction among benchmark-based allocation rules, technological deployment feasibility, infrastructure dependency and broader industrial transition conditions that affect the practical capacity of firms to respond to progressively tightening carbon constraints.
The fifth chapter analyses the relationship between future ETS auction revenues and the scale of investment required to support European decarbonisation objectives during the 2031–2040 period. Building upon alternative carbon-price and cap scenarios, the analysis investigates whether the tightening scarcity framework underpinning the ETS can maintain a structurally stable relationship with the financing needs associated with industrial decarbonisation, electricity-system transformation, infrastructure deployment and long-term transition investment requirements. In doing so, the chapter contributes to a broader reflection on the long-term sustainability of relying on ETS-generated revenues as a central pillar of European transition financing.
Taken together, the five chapters aim to provide a multidimensional assessment of the evolving ETS architecture and of its interaction with electricity markets, industrial transformation, financial-market structures, infrastructure conditions and long-term investment sustainability within the broader European decarbonisation framework. More broadly, the research seeks to contribute to a systemic reflection on how carbon pricing increasingly interacts with industrial policy, electricity-market design, strategic-transition objectives and the broader governance architecture underpinning the European climate transition.