EU's flexibility and challenges on path to carbon neutrality

On March 5, 2025, the European Commission released the Automotive Industry Action Plan (the Plan), aiming to balance climate goals with the pressures of industrial transformation. The plan seeks to accelerate the carbon neutrality process through flexible policy tools while enhancing the global competitiveness of the European automotive industry. The Plan has four core areas, including adjustments to CO₂ emission standards, the 2035 combustion engine ban review, supply chain resilience, and technological innovation, which represents a systematic policy response to the automotive industry following the implementation of the 2023 combustion engine ban.

1. CO₂ Emission Standards: Transition from Annual Assessment to a Three-Year Course

Policy Content:

The originally planned annual carbon emission target for 2025 has been adjusted to a three-year cumulative target over 2025-2027. If a car manufacturer fails to meet the target in a given year, it can compensate by exceeding emission reduction targets in subsequent years, with the overall goal remaining unchanged.

For example, if a manufacturer fails to reach the emission reduction target in 2025, it must offset the excess by selling more zero-emission vehicles (ZEVs) in 2026 or 2027.

Policy Motivation:

In 2024, the growth rate of electric vehicle (EV) sales in Europe slowed, compounded by high inflation and insufficient charging infrastructure, putting car manufacturers at risk of significant fines.

According to the Commission Implementing Decision (EU) 2023/1623 on August 3, 2023, starting in 2025, the average emission target for new passenger cars in the EU is 95 grams of CO₂ per kilometer, and for new vans, it is 147 grams of CO₂ per kilometer. The European Commission sets specific annual emission targets for each car manufacturer. If a manufacturer's fleet exceeds its specific CO₂ emission target in a given year, the manufacturer must pay an excess emission penalty of €95 per gram per kilometer for each new car registered that year. For non-compliant manufacturers, these fines can quickly accumulate to substantial amounts.

The new regulation provides a buffer period for the industry, avoiding short-term shocks.

Chart 1: EU CO₂ Emission Target Adjustment Overview

2. 2035 "Combustion Engine Ban" Review Brought Forward: The Battle for Technological Neutrality

Policy Adjustment:

The review of the "combustion engine ban" (assessing progress toward zero-emission goals), originally scheduled for 2026, has been moved forward to 2025.

The principle of "technological neutrality" is maintained, allowing the sale of internal combustion engine vehicles using carbon-neutral synthetic fuels after 2035, provided technical measures prevent the use of fossil fuels.

3. Supply Chain and Technological Innovation: Strengthening the Local Battery Industry

Policy Support:

A total of €1.8 billion will be invested in the battery raw material supply chain, aiming to cover 80% of the EU's battery demand and reduce reliance on countries like China.

The European Connected and Automated Driving Alliance will be promoted, with plans to accelerate the deployment of autonomous driving technologies through a €1 billion public-private partnership fund.

Challenges:

The expansion of European battery production capacity has been slow, and imported batteries hold a significant cost advantage. The EU plans to enhance local competitiveness through "European content requirements" and direct production subsidies.

The EU also plans to introduce relevant legislation in 2025, specifying local content requirements for electric vehicle batteries and their components.

Chart 2: EU Battery Supply Chain Targets (2030)

4. Social Equity and Industrial Transformation: Worker Skills and Trade Protection

Labor Transition: The European Social Fund (ESF+) will support the reskilling of automotive workers to address job losses due to electrification.

Trade Defense: Anti-subsidy investigations will be conducted on imported electric vehicles to protect local companies from low-price competition.

Summary:

The EU's policy adjustments aim to strike a balance between the vision of carbon neutrality and industrial realities by easing emission reduction timelines in the short term, strengthening local manufacturing in the medium term, and maintaining technological openness in the long term.

However, the economic challenges of synthetic fuels, the nature of the battery supply chain globalization, and the overwhelming dominance of China and the U.S. in the EV sector will continue to test the resilience of Europe's automotive industry.

Therefore, 2025 may become a critical turning point. If the review confirms that synthetic fuels are difficult to scale, the EU may be forced to return to a more aggressive electrification path; otherwise, diversified technological pathways could open up differentiated opportunities for European automakers.

Written by Aggie Hu, huchenying@mysteel.com