Free Allocation within the EU ETS is the distribution of carbon allowances (permits to emit) to industrial installations at no cost. This policy primarily aims to prevent "carbon leakage" by safeguarding the competitiveness of EU industries at high risk of relocating to regions with weaker climate regulations.
Free Allocation, also known as the distribution of gratis allowances, is a core mechanism of the European Union Emissions Trading System (EU ETS). It involves granting a specific number of European Union Allowances (EUAs) for free to eligible companies, particularly in energy-intensive and trade-exposed sectors like steel, cement, and chemicals. The primary goal is to mitigate the risk of carbon leakage, a situation where companies move their production outside the EU to avoid the costs associated with climate policies, leading to a net increase in global emissions.
This policy ensures that vital European industries can remain competitive on the global stage while they transition towards lower-carbon operations. Rather than being a blanket subsidy, free allocation is a targeted, transitional measure designed to support decarbonisation without crippling key economic sectors.
How Does Free Allocation Work?
The process is benchmark-based, meaning it rewards efficiency. The number of free allowances an installation receives is not random; it is calculated through a structured methodology:
- Benchmarking: The European Commission establishes performance benchmarks for different products (e.g., a tonne of steel or cement). These benchmarks are based on the average emissions of the top 10% most efficient installations in that sector across the EU.
- Data Collection: Companies must report their historical production data and emissions to national authorities.
- Allocation Calculation: An installation's free allocation is determined by multiplying its historical production level by the relevant product benchmark. If a plant is less efficient than the benchmark, it will not receive enough free allowances to cover all its emissions and must purchase the remainder through auctions or on the secondary market
[discover how to invest in EUAs on the secondary market]. - Phasing Out: Free allocation is not permanent. The EU is gradually phasing it out in favour of 100% auctioning. This transition is being managed alongside the introduction of the Carbon Border Adjustment Mechanism (CBAM), which will level the playing field by placing a carbon price on certain imported goods.
Concrete Examples
- Case 1: A German Cement Manufacturer
A cement plant in Germany faces direct competition from plants in countries with no carbon pricing. Without free allocation, the cost of buying EUAs for all its emissions would make its product significantly more expensive than imported cement. Free allowances help level this playing field, preventing the German plant from shutting down and production (and emissions) simply moving elsewhere. - Case 2: A French Steel Producer
A steel company needs to make massive capital investments to switch to green hydrogen-based production. During this transition period, free allocation reduces its compliance costs under the EU ETS. This financial breathing room allows it to direct more capital towards the innovative technologies required for deep decarbonisation, supporting the long-term climate goals of the EU.
External Resource: For official details, refer to the European Commission's documentation on Free allocation.