Is Carbon Pricing Really Driving Up Europe’s Energy Bills?

One month has passed since the US-Israeli attack on Iran, which triggered the largest supply disruption of oil in history, pushing crude oil prices above $100 per barrel, from around $70 before the war. Gas prices in Europe have climbed to €50 per MWh, up from €30.

This disruption is largely due to the closure of the Strait of Hormuz and the threat of continued military strikes on energy infrastructure in the Middle East. Rising prices have revealed, once again, how deeply Europe’s prosperity depends on imported energy it does not control.

In response, EU leaders are weighing several short-term levers: targeted price interventions (including a possible gas price cap), tax cuts and subsidies for households and industry, and cuts to network charges. A fourth lever has become the most politically charged: adjusting the Emissions Trading System (ETS, which is due to be revised in July 2026).

While the future design of the ETS is important in itself, it has a rather limited impact on energy costs. The EU should confront its energy dependency heads on rather than tweak the ETS for short term relief.

How ETS Works

The ETS is the EU’s flagship climate policy tool, in place since 2005. It works by setting a cap on the total greenhouse gas emissions allowed from industry and power generation, and requires companies to buy carbon allowances for every tonne of CO₂ they emit. The cap is reduced over time, making carbon-intensive activity progressively more expensive and incentivising investment in cleaner alternatives.

The ETS has helped reduce emissions from power and industry plants by half since 2005. It has also been a source of inspiration, with over 80 carbon pricing instruments in place worldwide.

The ETS does feed into electricity prices: companies that generate electricity (such as power stations, gas plants, wind farms) pass on the cost of their carbon allowances when setting their prices. But the scale of this passed-on cost is frequently overstated.

ETS-related costs account for roughly 11% of the average EU electricity bill. This is real, but modest compared to the cost of energy commodities themselves, which make up 56% of the bill. Network charges (18%) and taxes and levies (15%) outweigh the costs of ETS too.

What Drives Electricity Prices

Under the current electricity market design, the last power plant needed to meet demand sets the price for everyone. Hence countries that rely on gas for electricity generation are hit strongest by the current situation.

In Italy, gas-fired plants have set the market price in 89% of hours in 2026. This has pushed the average price for electricity to €142 per MWh. In Spain, where gas sets the price in just 15% of hours, the average price is 59€.

This explains why Germany, the Netherlands, Italy and Belgium have seen electricity prices surge, while less gas-dependent countries like France, Spain, Portugal and the Nordics have been comparatively shielded.

Carbon Prices Fall as Leaders Signal Appetite for a Watered-down ETS

Still, leaders from Member States and industry have been vocal in their critique of the ETS. Carbon prices on the market have already fallen considerably in recent weeks, as traders anticipate that political pressure could lead to a watering-down of the system.

The most market-moving statement came from German Chancellor Friedrich Merz during an industry summit in Antwerp in early February, signalling he was open to revising it or suspending it.

Italian Prime Minister Georgia Meloni argued that the ETS inflates the price of all electricity, making it a structural drag on industrial competitiveness. Italy went so far as to urge the Commission to suspend the system until its scheduled review in July 2026.

At the most recent European Council Summit on 19-20 March, leaders from Italy, Austria, and Poland cited competitiveness challenges to push for substantial changes to the ETS.

Short Term Tweaks to ETS Ahead of July Review

The ETS was already scheduled for a broader review in July 2026. Political pressure prompted Ursula von der Leyen to announce two targeted measures to be presented in the coming days.

The first would update the benchmarks used to calculate free allowances — the credits that energy intensive industries receive to cushion the impact of carbon pricing during their transition. Adjusting these benchmarks could reduce costs for some carbon-intensive industries.

The second involves strengthening the Market Stability Reserve, the mechanism that regulates the supply of carbon allowances in the market. The Commission’s proposal would add an emergency brake to this mechanism: during acute price spikes, credits that would normally be permanently cancelled would instead be kept in circulation, preventing sudden surges.

These more targeted adjustments still leave the July review as the vehicle for any bigger decisions.

Protect the Price Signal

The July 2026 ETS review represents a genuine opportunity, but also a risk. The ETS has cut emissions and generated over 245 billion euro to help finance the clean energy transition. Any backtracking or decreased ambition will not lower energy bills significantly. Instead, it will delay the investments that actually would.

Fossil fuel dependency is the principal driver of Europe’s energy costs. Caving to political pressure on the ETS would undermine the long-term investment signal that industry needs. The July review should deliver reform where warranted to meet climate targets or reward industrial decarbonisation frontrunners, not reward laggards or jeopardise a strong carbon price.