EU ETS Reform: Part II – Free allocation

For sectors covered by the CBAM, free allocation will be phased out completely only by 2035.


16 July 2021

As part of its Fit for 55 legislative packages, the European Commission will introduce the Carbon Border Adjustment Mechanism (CBAM). The measure is designed, according to the EU executive, to prevent the risk of carbon leakage and will work as follows: “EU importers will buy carbon certificates corresponding to the carbon price that would have been paid, had the goods been produced under the EU’s carbon pricing rules.”

The CBAM will involve a transitional phase starting in 2023 during which importers will have to report emissions without any payment obligations. The mechanism will be introduced in 2026 and will initially apply to iron and steel, aluminum, cement, chemicals and electricity generation.

The CBAM will involve phasing out free allowances in order to avoid contravening international trade rules. Both measures are considered safeguarding policies and having them both in place would mean “doubling up” the protection on EU industry. However, for the sectors that will be covered by the CBAM, free allocation will be phased out progressively, starting from 2026 until 2035, as the new mechanism is phased in.

According to the EU executive, “the reduction of free allocation should be implemented by applying a factor to free allocation for CBAM sectors, while the CBAM is phased in. This percentage (CBAM factor) should be equal to 100 % during the transitional period between the entry into force of [CBAM Regulation] and 2025, 90 % in 2026 and should be reduced by 10 percentage points each year to reach 0 % and thereby eliminate free allocation by the tenth year.”

For installations covered by the obligation to conduct an energy audit, the Commission also intends to make free allocation conditional on investments to increase energy efficiency. If the criterion for conditionally is not met, installations “would see their free allocation reduced.” Furthermore, the free allowances for aircraft operators will be reduced gradually and phase out completely by the end of 2026