Decarbonisation vs competitiveness — careful balancing of EU ETS’s dual aim

I. Introduction 

The European Union positioned itself at the forefront of global climate governance, pursuing an ambitious agenda to achieve climate neutrality by 2050. The decarbonisation of the European economy significantly rests on the EU emissions trading system (ETS), established under Directive 2003/87/EC. As a market-based instrument, the ETS pursues a dual objective — achieving effective reductions in greenhouse gases (GHG) emission while preserving competitiveness of European industries through a harmonised, cost-efficient framework. Central to this balance is the system of free allocation of emission allowances, designed to prevent carbon leakage and to incentivise green-technological transition, with an underlying aim of coherence across the internal market.

The Opinion of Advocate General Ćapeta delivered on Case C519/24 investigates the extent to which MS may supplement the ETS at national level. The Opinion goes to the heart of the free allowances’ two-fold rationale and the division of competence in ETS governance. Ćapeta asks whether a national fiscal measure can supplement the ETS, in a way that de facto undermines its aims. 

The case thus offers a neat illustration of several course themes: the ETS’s architecture and division of powers within the system, the rationale and objectives of free allowances, and the scope and limits of EU harmonisation in this area. This case note introduces the legal framework before following AG’s reasoning, and concludes with a critical reflection on its logic and forward-looking implications.

II.  Legal framework of EU ETS

The ETS operates as a cap-and-trade mechanism. It establishes a progressively decreasing EU-wide ceiling limiting total available GHG emissions for all covered installations. Each operator must surrender, by 30 April of each year, a number of allowances equal to its verified annual emissions. Allowances can be acquired by auction (a default method since the third trading period) or through allocation of free allowances, being subject to specific accounting methods. 

Free allowances serve a dual purpose at times requiring conflicting measures. The primary justification is preventing carbon leakage; the risk that carbon-intensive industries relocate production outside the EU to less regulated jurisdictions, displacing (rather than reducing) global GHG emissions. The second is to incentivise decarbonisation within those same sectors, by conditioning free allowances on carefully calculated performance benchmarks set at the level of top 10% most efficient EU installations. Both objectives are laid down in the Directive 2003/87, yet they might pull in opposite directions. Maximising competitiveness tends to slow decarbonisation, and vice versa. 

The Nitrogénművek case, concerns the fourth, centralised trading period, so the revised ETS Directive 2009/29 applies. The key provisions are Art.10a establishing rules for harmonised free allocations. and Art.10b referring to measures to support certain energy-intensive industries in the event of carbon leakage risk, together with with Commission Delegated Regulation 2019/331, which sets the harmonised benchmarks, and Commission Delegated Decision 2019/708, which lists the sectors at high risk of carbon leakage eligible for up to 100% free allowance coverage.

III. Background of the dispute

In July 2023, against the backdrop of the post-COVID-19 economic situation and the macroeconomic consequences of Russia’s aggression in Ukraine, Hungary adopted a Government Decree emergency economic measure imposing a retroactive fiscal charge on installations receiving significant free allocation of emission allowances under the EU ETS. Specifically, those producing (1) average certified CO2 emissions above 25,000 tonnes over the preceding three years; and (2) having received free allowances covering at least 50% in the preceding year. These strict thresholds effectively targeted operators granted 100% free allowance coverage, precisely those sectors the EU classified as at high risk of carbon leakage. The Decree entered into force only three days after publication and applied retroactively.

Nitrogénművek Vegyipari, a Hungarian nitrogen fertiliser producer within the scope of the Decree requested a tax return, arguing the measure was contrary to both EU and Hungary's Basic Law. After the claim was rejectby tax authorities, the applicant brought judicial review proceedings. It argued that the Decree (i.) deprived free allowances of their compensatory value, undermining the objective to avoid carbon leakage, (ii.) was arbitrary and discriminatory against certain operators within and outside its scope, as well as vis-a-vis operators in other MS, and (iii.) restricted the freedom of establishment, freedom of services, and the right to property. The national court referred four preliminary questions to the CJEU.

IV. The AG’s analysis

​Ćapeta’s reasoning turns on the first preliminary question. She reads it as asking whether Articles 1, 10a and 11 of Directive 2003/87, together with the objectives they pursue, preclude a national measure that selectively taxes emissions from installations entitled to significant free allowances. She considers the remaining questions unnecessary because, if the measure conflicts with the Directive, it is already unlawful under EU law and there is no need to examine it separately against the fundamental freedoms or property rights.  

Full harmonisation and MS remaining powers

Ćapeta explains that, by the fourth trading period, the free-allocation-regime had become fully harmonised at the EU level, serving two linked objectives. First, preventing carbon leakage and preserving the competitiveness of EU industry, and second, maintaining pressure to decarbonise through harmonised benchmarks and allocation rules. MS may not unilaterally alter the scope or value of free allocations once the EU-level framework is approved. MS cannot interfere with the system even if they consider the harmonised framework insufficiently ambitious. The only express competence left to MS is Art.10a(6), which permits financial support measures for sectors facing significant indirect electricity costs due to their carbon leakage risk, subject to competition and State aid rules. The AG uses this exception to prove the rule - any MS competence to act alongside the harmonised system must be expressly conferred and narrowly construed.

On that basis, Ćapeta draws a distinction between two types of national charges. A general carbon tax applicable to all GHG emitters in a MS is in principle permissible as it creates a broad increase of production costs and does not specifically target ETS beneficiaries, hence not affecting freedom of establishment nor incentivising exit from the internal market. By contrast, a selective charge imposed only on recipients of significant free allowances is incompatible, because it strips those allowances of economic value and compensatory effect intended by the EU legislature.

Application to the case

Applying this framework, Ćapeta identifies three main incompatibilities:

First, the Decree targets precisely those operators designated for competitive protection through 100% free allowance coverage. By exclusively taxing those operators, Hungary converts free allowances into paid ones, directly contradicting the carbon leakage prevention objective. Additionally, the retroactive character of the charge means that operators had no opportunity to adjust prices or behaviour. 

Second, when composing national lists, MS must account for cross-installation relationships to ensure equal treatment and avoid competitive distortions. The Commission approves those integrated lists. By excluding operators receiving heat and fuel benchmarks without justification, Hungary differentiates within that Commission-approved list and effectively amends it unilaterally, a competence reserved to the EU legislature. The measure cannot be justified by the reasoning in Iberdola invoked by the defendant. In that case, charges on electricity operators were designed to prevent them from passing the value of free allowances on to consumers, therefore correcting the ETS in line with the polluter pays principle, whereas in this case the measure does not correct a distortion, but instead negates the very protection and incentive structure built into the ETS.

Third, drawing on ŠKO-Energo and PPC Power, the AG confirms that contradicting one objective of the free allowances system suffices to render a national measure incompatible with ETS Directive. Since the Decree undermines both objectives, the domestic budgetary purpose as such (responding to war and pandemic effects) is legally irrelevant.

V. Critical reflection 

​AG Ćapeta is known for a realist approach to EU law. She believes that legal questions rarely have one correct answer, that judgments reflect choices rather than objective truths, and that reasoning must adapt to changing contexts. The Opinion reflects that approach. Applying teleological analysis, AG reads ETS Directive through the lens of its two-fold objectives, openly acknowledging that those aims may require conflicting measures, and remaining alert to the practical implications of the ruling for the ETS as a whole. She explicitly recognises that the balance struck by the EU legislature between maintaining competitiveness and incentivising decarbonisation is a fragile one. 

Looking in the future

To date, litigation has not undermined the ETS, and the Opinion follows that line. It draws firm boundaries against unilateral MS interference, safeguarding the ETS as the Union’s primary decarbonisation instrument and a cornerstone of the climate package, covering 45% of EU emissions. This approach aligns with Kotzampasakis and Woerdman, who argue that the dual ETS legal objectives (environmental effectiveness and economic efficiency) function as an integrated evaluation framework: undermining one necessarily distorts the other. In that context, the AG's harmonisation ceiling reasoning is functionally necessary.

Yet, in the fourth trading period, 63 sectors representing 94% of ETS emissions remain eligible for free allowances. Evidence shows that free allocation has increased industry revenues, without delivering sufficient emissions’ reduction. In this context, free allowances serve competitiveness more than decarbonisation, mirroring the Union’s broader policy trajectory. Recent introduction of the Competitiveness Compass and Omnibus simplification package signal a political shift in which environmental protection is seen as secondary to competitiveness. The AG does not hierarchise these aims, but focuses on the measure’s flows preserving the legislative balance struck at EU level. 

The restructuring potential of CBAM

​ETS is a learning-by-doing instrument, dynamically correcting its own insufficiencies. The AG briefly mentions the CBAM, as a mechanism that might restructure the ETS model over time. CBAM imposes a carbon tariff on imports at the EU border, mirroring the ETS cost and structurally addressing the risk of carbon leakage that justifies free allowances. The main aim of the new mechanism is to incentivise industry to actively move towards a more green economy, while staying competitive. Ćapeta notes this transition but finds the case unaffected by it. Even if CBAM renders free allocations obsolete, the precedential value of that judgment will shape how MS fiscal autonomy vis-à-vis ETS is understood and remains crucial for its effective, balanced functioning.

Applying Ćapeta’s own realist approach, it is worth asking how the system will affect such cases in the future. If the CBAM functions as designed, carbon leakage within covered sectors ceases to be a systemic risk and the two-fold objectives of the free allowances no longer conflict, rendering free allocations progressively obsolete. This reflects the dynamic nature of ETS adapting to arising issues and improving its functionality. At the same time, CBAM has the potential to create a Brussels effect in climate policy. By leveraging the EU's market power, it projects environmental standards beyond its borders. CBAM's impact is both de facto, by altering the incentives of stakeholders that previously resisted carbon pricing and now have reason to decarbonise to retain profitable market access to EU market, and de jure, by encouraging third-country governments to introduce equivalent domestic carbon pricing mechanisms compatible with EU’s rules. In this way, CBAM strengthens the ETS’s environmental objective without sacrificing competitiveness.

Proper functioning of the ETS is essential for achieving the binding targets under the Climate Law. However, the case’s relevance for environmental protection extends beyond the EU borders. It raises broader concerns regarding the risk of carbon leakage, particularly to the third-countries not subject to equivalent regulations. Rather than contributing to the reduction of global greenhouse gas emissions, this would merely displace emissions geographically, thereby undermining the environmental integrity of the EU climate regime.

From a systemic perspective, this outcome would contradict both the objectives of EU environmental policy under Art.191 TFEU and the broader principle that environmental protection must address transboundary harm. Given the inherently borderless nature of climate change, regulatory fragmentation at MS level not only weakens the effectiveness of EU measures but creates scope for unilateral measures that may destabilise the ETS’s harmonised carbon pricing architecture and cause further environmental harm. 

VI. Conclusion 

The Opinion confirms that ETS free-allowance system constitutes a fully harmonised framework that MS cannot circumvent through selective fiscal measures, adding another layer to an already well-established web of ETS jurisprudence. The reasoning is coherent and legally sound, yet it arrives at a moment of political reordering of EU priorities in which environmental ambition risks being subordinated to market concerns.

It remains to be seen whether the CJEU will ultimately follow the AG's reasoning. But the judgement will certainly shape the future of ETS balance between legally centralised model and control power on the MS level, and the duality of ETS objectives, and ultimately the EU’s ambition to  become a global climate neutrality leader.

Reference List

EU Legislation:

Directive 2003/87/EC of the European Parliament and of the Council of 13 October 2003 establishing a system for greenhouse gas emission allowance trading within the Union and amending Council Directive 96/61/EC 

Commission Delegated Regulation (EU) 2019/331 of 19 December 2018 determining transitional Union-wide rules for harmonised free allocation of emission allowances pursuant to Article 10a of Directive 2003/87/EC of the European Parliament and of the Council

Commission Delegated Decision (EU) 2019/708 of 15 February 2019 supplementing Directive 2003/87/EC of the European Parliament and of the Council concerning the determination of sectors and subsectors deemed at risk of carbon leakage for the period 2021 to 2030

Commission Decision (EU) 2021/355 of 25 February 2021 concerning national implementation measures for the transitional free allocation of greenhouse gas emission allowances in accordance with Article 11(3) of Directive 2003/87/EC of the European Parliament and of the Council

Regulation (EU) 2023/956 of the European Parliament and of the Council of 10 May 2023 establishing a carbon border adjustment mechanism

Hungarian Law:

Hungarian Government Decree No 320/2023 (VII. 17.) Kormányrendelet

Case Law:

Opinion of AG Ćapeta, Case C-519/24, Nitrogénművek Vegyipari Zrt. v Nemzeti Adó- és Vámhivatal Fellebbviteli Igazgatósága, 9 October 2025

Cases C-566/11, C-567/11, C-580/11, C-591/11, C-620/11 and C-640/11, Iberdrola and Others, EU:C:2013:660

Case C-43/14, ŠKO–Energo, EU:C:2015:120

Case C-302/17, PPC Power, EU:C:2018:245

Academic sources:

Damien Meadows and Beatriz Yordi and Peter Vis, Addressing Carbon Leakage under the EU ETS, in Jos Delbeke, Delivering a Climate Neutral Europe, Routledge, 2024, chapter 4;

Kotzampasakis M, Woerdman E. The Legal Objectives of the EU Emissions Trading System: An Evaluation Framework. Transnational Environmental Law

Mehling, M. A., Dolphin, G., & Ritz, R. A. (2025). The European Union’s CBAM: averting emissions leakage or promoting the diffusion of carbon pricing? Journal of Environmental Policy & Planning, 27(6), 687–705

Environmental Law Lecture Series by Stefan E. Weishar

Additional sources:

Borderlines, „Interview with Advocate General Ćapeta”, https://open.spotify.com/episode/4aedYRrXEFLLUGmJBf0jyN?si=oZ8fzwIkTXOWHdwbovlKXw 

European Commission, “Free Allocation”, European Commission last accessed 25 March 2026 at https://climate.ec.europa.eu/eu-action/eu-emissions-trading-system-eu-ets/free-allocation_en

European Commission, “Carbon Border Adjustment Mechanism”, European Commission last accessed 25 March 2026 at https://climate.ec.europa.eu/eu-action/eu-emissions-trading-system-eu-ets/free-allocation_en