EU ETS Plunge: Italy's Suspension Demand Triggers EUA Sell-Off

The European carbon market is currently a lesson in the violent disparity between political rhetoric and regulatory mechanics. On February 26, 2026, the EU Emissions Trading System (ETS) experienced a textbook capitulation event, driven not by a change in the carbon budget, but by a coordinated political assault that triggered a massive unwinding of speculative positions.

The headline catalyst was blunt: Italian Enterprise Minister Adolfo Urso formally requesting a suspension of the ETS, flanked by a "Friends of Industry" coalition of 13 member states demanding urgent reform. The market reaction was visceral. The December 2026 benchmark contract collapsed to an intraday low of €69.33/mtCO2e, a level not seen in nine months, before compliance buyers stepped in to engineer a fragile recovery to €70.23 by 1210 GMT.

For market professionals, the 25% peak-to-trough decline since mid-January represents more than just volatility; it signals a fundamental repricing of political risk premium. However, the data suggests this sell-off is a technical washout of crowded long positions rather than a structural breakdown of the market’s supply fundamentals.

The Anatomy of a Washout: Speculators Exit, Compliance Enters

The velocity of the crash—dropping over €20/tonne in six weeks—bears the hallmarks of a liquidity crisis exacerbated by positioning extremes. In mid-January, investment funds held a record net long position approaching 110,000 contracts. This crowded trade was predicated on a rational thesis: the 2026 supply cliff caused by the phase-out of free aviation allowances and the expansion of maritime coverage.

When German Chancellor Friedrich Merz first hinted at "revising" the ETS on February 12, followed by Urso’s suspension demand on February 26, the thesis didn't break, but the risk tolerance did. Algorithms and risk managers forced a liquidation cycle. Commitment of Traders data shows funds had already cut net longs to 94 million EUAs by early February, a figure that has likely plummeted further in the unreleased data covering this week's panic.

Critically, as liquidity evaporated—daily volumes on the Dec '26 contract withered to under 50,000 lots—bid-ask spreads widened, exacerbating the downward pressure.

Yet, a floor emerged. While financial players fled, compliance entities (utilities and industrials with legal surrender obligations) began to scale in. Data indicates that operators increased their long positions by 2 million EUAs (3.7%) to 56.4 million as prices approached €70. This divergence is the defining signal of the current market: speculators are selling headlines, while industrials are buying value.

The Fundamental Disconnect: Politics vs. Math

The market is currently pricing in a probability of legislative intervention that technical analysis suggests is nearly impossible to execute in the short term. Changing the ETS Directive requires a co-decision process involving the Commission, Parliament, and Council—a timeline of 12 to 18 months.

Traders dumping positions at €70 are effectively betting that the "Friends of Industry" coalition can bypass EU law. However, the supply math for 2026 is already locked in:

• Cap Reduction: The linear reduction factor continues to slice supply by 4.3% annually.
• Sectoral Expansion: Maritime coverage hits 100% in 2026 (up from 70%), and aviation free allocation vanishes.
• Net Deficit: Analysts project a supply reduction of nearly 180 million tonnes year-on-year.

Even if the Commission bows to pressure during the Q3 2026 review, any structural changes—such as slowing the reduction factor or extending free allocation—would legally apply from 2028 onwards. The 2026-2027 vintage years remain structurally tight. As ING analysts noted, the mechanical reality of the ETS means the market is short allowances regardless of what Minister Urso says in a press conference.

Contagion and Cross-Asset Correlations

The shockwaves from the EUA collapse have created distinct winners and losers across the European energy complex, offering clues to how the market interprets the "reform" narrative.

1. The UKA Collapse: The UK Emissions Trading Scheme has acted as a high-beta proxy for EU political risk. UK Allowances fell to GBP 45.65/mtCO2e, a near 20% decline, widening the EUA-UKA spread to a historic €22.01. The market is pricing in a scenario where UK politicians, seeing EU weakness, abandon their own alignment ambitions.

2. Equity Divergence: The stock market offered a brutally honest assessment of the proposed "reforms."

• Cement: Shares in Heidelberg Materials and Holcim dropped 7-9%. These companies have invested billions in decarbonization based on high carbon prices; a weaker ETS destroys their competitive moat against high-carbon rivals.
• Chemicals: Conversely, chemical sector equities outperformed. The market correctly identified them as the primary beneficiaries of the "Friends of Industry" demands for extended free allocation.

3. Power Spreads: European gas prices remained relatively stable between €29-33/MWh, decoupling from carbon. However, the lower carbon price lowers the coal-to-gas switching price, potentially incentivizing a short-term increase in coal burn—an ironic outcome for a policy ostensibly designed to protect "green" industry.

Technical Analysis: The Battle for €70

From a technical perspective, the market is in "no man's land" between the collapse of the bullish trend and the establishment of a new range.

• Support: The €70.00 psychological level held during the February 26 session, reinforced by the intraday bounce from €69.33. A weekly close below €70 opens a trapdoor to the €60-65 range, the next major historical support.
• Resistance: The 200-day moving average sits at €79.06. Until prices reclaim this level, the trend remains bearish.
• Volatility: One-month volatility has expanded sharply. Traders should expect wide intraday ranges as the market digests headlines from Brussels.

Conclusion: A Buying Opportunity for the Brave?

The February 26 crash is a classic event-driven repricing. The political noise is deafening, but the regulatory signal remains unchanged for the immediate future. The "Friends of Industry" may succeed in softening the trajectory for 2030, but they cannot manufacture allowances for April 2027 compliance.

For compliance buyers, the current levels represent a discount on inevitable obligations. For speculative funds, the washout has cleansed the excessive length that made the market fragile in January. The risk now has shifted: if the Commission holds the line—as President von der Leyen's defense of the ETS suggests she might—the short squeeze on the rebound could be as violent as the collapse.

What to Watch

• Weekly COT Report: Look for the "Commercial" category. If compliance entities continue to increase net longs while funds sell, the floor at €70 is solidifying.
• The Q3 Review Drafts: Leaks regarding the Linear Reduction Factor (LRF) will be critical. Any rumor of reducing the LRF below 4.3% will trigger fresh selling; confirmation of the status quo will spark a rally.
• Auction Cover Ratios: Watch demand at daily auctions. Weak cover ratios (<1.5) indicate buyers are on strike; strong ratios suggest the physical market is absorbing the paper market's panic.
• German Politics: Chancellor Merz started this fire. If Berlin clarifies that "revision" does not mean "suspension," the risk premium will evaporate quickly.