Europe has destroyed the best liberal instrument for climate policy. And now it must reimburse its costs.

The EU ETS was designed as a market instrument. Today, it risks becoming a tax with compensatory mechanisms. The Italian energy decree is only the latest symptom.

By Andrea Ronchi

Founder and CEO, CO2 Advisor

Deputy Director, Carbon Market Outlook – Energy & Strategy Group, Politecnico di Milano

Can one be liberal, pragmatic, and supportive of decarbonization?

I write as a liberal, before even writing as a specialist in energy and carbon markets. I am the founder and CEO of CO2 Advisor and Deputy Director of the Carbon Market Outlook at the Energy & Strategy Group of Politecnico di Milano.

I believe in markets as the most powerful mechanism for creating wealth and discovering efficiency. I also believe that one can uphold environmental values without embracing environmentalism in its ideological form.

One can support decarbonization while, at the same time, supporting even more strongly the survival and competitiveness of Europe’s industrial fabric.

Climate policies must create value, not destroy it.

And this is precisely where the great paradox of the European ETS begins.

The energy decree and the paradox of the ETS

In recent days, the EU ETS has returned to the public debate in connection with the Italian government’s upcoming energy decree. According to draft versions currently circulating, the decree may introduce reimbursements for ETS compliance costs borne by thermoelectric power producers.

This is only the latest manifestation of a paradox that has been developing for years: we continue introducing distortions to correct distortions created by previous interventions.

This is particularly unfortunate because the ETS was born from a profoundly liberal idea. It was not conceived as a tax. It was conceived as a market.

The original intuition was simple and powerful: set a cap on total emissions and allow operators to freely trade emission allowances. No mandated technologies, no centrally planned industrial policies, no predetermined winners or losers. Only a quantitative constraint, combined with the freedom for economic actors to adapt in the most efficient way possible.

Those who reduce emissions at lower cost profit. Those who cannot must pay. Every transaction creates value because it is voluntary and mutually beneficial.

This is what a market is.

When the ETS was truly a market

For many years, the system functioned exactly as intended. Allowances were distributed for free in declining quantities over time.

Companies that innovated and reduced their emissions freed up allowances, which they could sell. The costs of one company became the revenues of another. Wealth remained within the productive system and was reallocated toward the most efficient operators.

As demonstrated by the Carbon Market Outlook 2025 of the Energy & Strategy Group at Politecnico di Milano, of which I serve as Deputy Director, the ETS has been one of the most effective climate policies ever implemented. It delivered significant emission reductions while maintaining a sustainable impact on industrial competitiveness.

This success was not achieved despite the market, but because of it.

The shift from free allocation to auctions

The problem emerged when the European Union progressively replaced free allocation with auctions.

As a result, the costs of Company A no longer became the revenues of Company B. Instead, they became fiscal revenue.

Resources that were previously circulating within the industrial system began to be extracted and transferred to national and European public budgets, where they are redistributed through spending programs often characterized by extremely high levels of inefficiency.

At that point, the system ceased to function as a market and began to function as a fiscal instrument.

From market signal to fiscal extraction

Companies covered by the ETS have rarely faced costs exceeding €100 per tonne of CO2.

Yet when the same resources are redistributed through public spending programs, they often finance measures with implicit costs exceeding €10,000 per tonne of CO2 avoided.

This is no longer a market. It is a tax.

And like any poorly designed tax, it generates distortions.

An increasing number of industrial sectors—steel, cement, ceramics—are receiving compensation to offset ETS costs. Now, the Italian energy decree proposes extending such compensation to electricity producers as well.

The result is a system where the carbon price formally exists but is politically neutralized through compensatory transfers.

The paradox is clear: a cost is introduced to create efficiency incentives, and then reimbursed to mitigate its economic consequences.

This is exactly the dynamic I described in the opening of my book Carbon Markets, published by Class Editori: environmentalists resist the commodification of nature, while traditional industrial interests resist the taxation of air.

The outcome is the worst possible compromise: a system that is no longer a market, yet not a transparent tax either. It is a hybrid structure that preserves the costs of both while eliminating the benefits of either.

How to save the ETS: two essential reforms

Yet the solution exists, and it is fully consistent with the principles of a market economy.

The first step is to restore a system primarily based on declining free allocation of allowances, drastically limiting the role of auctions. The objective is not to eliminate the carbon price, but to ensure that the price emerges from market transactions rather than fiscal extraction.

In this way, resources would remain within the productive system, rewarding efficient operators and driving innovation, instead of being drained into public spending.

The second step is to extend the market to all real and verifiable emission reductions, including those occurring outside the direct ETS perimeter.

Any intervention—energy efficiency, circular economy, sustainable mobility, industrial innovation—should be able to generate tradable carbon credits.

This would allow the market itself to discover the most efficient decarbonization solutions, without relying on subsidies, central planning, or compensatory mechanisms.

A market creates value. A tax destroys it.

A true carbon market does not destroy wealth. It creates it.

It creates incentives for innovation. It creates efficiency. It creates economic growth.

Most importantly, it creates social consensus, because economic actors are not subjected to a tax—they participate in an opportunity.

If the current trajectory continues, the risk is the opposite: transforming one of the most effective climate policy instruments ever created into a symbol of policy failure.

The introduction of ETS2, which will extend carbon pricing to sectors closer to everyday citizens, risks amplifying these distortions even further unless fundamentally reconsidered.

The real failure is not the carbon market. It is the decision to stop using it as a market.

The real urgency today is not to abolish the ETS, but to save it—by restoring its original nature as a true market.