Italy Requests EU ETS Suspension: Carbon Prices Crash 22%

The European Union’s Emissions Trading System (ETS)—the cornerstone of global climate policy and the world’s largest carbon market—is facing its most severe political stress test since the sovereign debt crisis.

On February 26, 2026, Italy formally requested the suspension of the EU ETS pending a comprehensive structural review. This is not merely rhetorical posturing. Under the cover of a €3 billion "Energy Decree," Rome has engineered a mechanism to effectively strip carbon costs from national electricity bills, challenging the fundamental integrity of the Single Market.

The market reaction was swift and brutal. EU Allowance (EUA) prices, which traded near €90 per tonne in mid-January, crashed to €70.96 by the close of trading on February 26—a 22% correction driven by political panic rather than fundamentals. For carbon market professionals, the era of "policy certainty" is officially over. We have entered a volatile new phase where industrial competitiveness is openly warring with decarbonization targets.

The Italian Gambit: Decoupling by Decree

Italy’s move, led by Industry Minister Adolfo Urso and Prime Minister Giorgia Meloni, is technically sophisticated and legally aggressive. The core of the Energy Decree is a reimbursement mechanism for gas-fired power plants.

Because gas plants typically set the marginal price of electricity in Italy (accounting for 42% of generation), their carbon costs are passed through to all wholesale electricity consumers. Rome’s decree proposes reimbursing these generators for their ETS compliance costs. By subsidizing the carbon cost at the point of generation, Italy intends to lower the wholesale electricity price for all buyers, effectively neutralizing the ETS price signal without formally exiting the system.

This is regulatory arbitrage on a grand scale. It converts an environmental levy into a state-subsidized transfer, aiming to align Italian power prices—currently among the highest in Europe—with global competitors.

The "Friends of Industry" Coalition

If this were solely an Italian revolt, the market might shrug. It is not.

Following Italy's lead, a coalition of 13 member states—dubbed the "Friends of Industry"—convened in Brussels. The group includes heavyweight economies: Germany, France, Poland, and Spain, alongside Italy. Their joint statement warned that "decarbonization should not be achieved by deindustrialization," a direct challenge to the Commission’s "Fit for 55" architecture.

The coalition’s demands are specific and structural:

• Immediate Suspension: A pause on ETS obligations (the "nuclear option" proposed by Italy and Slovakia).
• Price Ceilings: Czech Prime Minister Andrej Babis has called for a hard cap at €30/tonne—less than half current market value.
• Allocation Reform: A demand to postpone the phase-out of free allowances, currently scheduled to disappear by 2034 for CBAM-covered sectors.

This broadly aligned front shatters the previous geopolitical containment of anti-ETS sentiment, which was historically limited to coal-dependent Eastern European states. When Berlin and Paris join Rome in questioning the carbon price, the political risk premium evaporates, and the market reprices downward.

Market Impact: The Liquidation Event

The price action since mid-January has been a textbook liquidation event. Investment funds, sensing the shifting political winds, have cut net long positions to their lowest levels since October 2025.

• Carbon Prices: The drop from €90 to €70.96 represents a massive repricing of regulatory risk.
• Power Markets: Italian year-ahead power prices fell for seven consecutive sessions, dropping nearly 15% in February as traders priced in the potential removal of carbon costs from the stack.
• Equities: The reaction was split. Chemical stocks (e.g., BASF) rallied on hopes of lower input costs. Conversely, Cement stocks (e.g., Heidelberg Materials) fell nearly 6%. Why? Cement producers fear that dismantling the ETS could also unravel the Carbon Border Adjustment Mechanism (CBAM), removing their protection against cheap foreign imports.

The Legal Reality Check

Despite the panic, compliance officers and traders must distinguish between political noise and legal reality. Suspending the ETS is not within the power of the European Council or the Commission alone.

The ETS is enshrined in the 2003 Directive, amended by the "Fit for 55" legislation. Any suspension or fundamental change requires the "ordinary legislative procedure"—a co-decision process involving the European Parliament and the Council. As noted by analysts at BBVA, this process typically takes 12 to 18 months. There is no "emergency brake" clause that allows a member state to unilaterally suspend the market without breaching EU treaties.

Furthermore, Italy’s Energy Decree likely violates EU State Aid rules. By reimbursing gas plants for carbon costs, Rome is effectively subsidizing fossil fuels. The Commission has a strong legal basis to block the measure, setting up a high-stakes constitutional showdown between Brussels and Rome.

The Counter-Offensive

The defense of the ETS is already mobilizing. A bloc of Nordic business associations (representing Sweden, Denmark, Finland, and Norway) issued a joint letter to President von der Leyen on February 23, explicitly opposing suspension. Their argument is economic, not just environmental: the ETS provides the revenue and price certainty required for green capital expenditure.

Commission President Ursula von der Leyen is attempting to thread the needle. She has acknowledged the competitiveness crisis but defended the ETS’s record, noting emissions have dropped 40% while the economy grew 70%. Her strategy appears to be "reform, not repeal." Expect proposals to tweak the Market Stability Reserve (MSR) or adjust free allocation schedules, rather than a full suspension.

Strategic Implications

For market participants, the current sell-off presents a complex risk/reward profile.

1. For Compliance Buyers: The structural deficit of the ETS remains unchanged. The cap is still tightening. If the legal framework holds—which remains the base case—current prices around €70 may represent a significant discount to fair value once the political dust settles.
2. For Industrials: The push for extended free allocation is gaining real traction. Firms should reassess their hedging strategies for the 2027-2030 period, as the "cliffs" for free allowances may be smoothed out by political compromise.
3. For Investors: Volatility is the new normal. The market is no longer trading on gas spreads and weather alone; it is trading on headlines from Brussels and Rome.

What to Watch

• March European Council: Von der Leyen has promised to present "options for revision" at the upcoming summit. This will be the moment the Commission reveals its hand: will they offer token concessions or structural changes?
• State Aid Ruling: Watch for the Commission’s Directorate-General for Competition to open an investigation into Italy’s Energy Decree. A swift injunction would signal Brussels is ready to fight; a delay signals weakness.
• Auction Volumes: Monitor the Market Stability Reserve (MSR). If prices remain depressed, the MSR’s intake mechanism should theoretically tighten supply, testing whether the automated stabilizer can withstand political pressure.

The Bottom Line: The EU ETS is not going to be suspended tomorrow. The legal hurdles are immense. However, the political consensus that allowed carbon prices to march toward €100 has fractured. The market must now price in a permanent "political risk discount," capping the upside for EUAs until a new equilibrium between competitiveness and climate ambition is reached.