18 Jan 2022

Can ETS free allocation be used as innovation aid to transform industry?

Milan Elkerbout

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The EU may distribute free ETS allowances worth hundreds of billions of euros over the next two decades. This policy brief proposes an addition to free allocation rules, so that the free ETS allowances given to industry can be turned into innovation aid for very low-carbon producers, thereby helping companies transition to climate neutrality. Free allowances exist to mitigate carbon leakage risk, but current rules can put innovative climate neutral producers at a disadvantage vis-à-vis the carbon-intensive incumbents with which they need to compete.

While the EU’s proposed carbon border adjustment mechanism would gradually reduce free allocation, many sectors may be excluded from this new mechanism at first, while transitional periods also result in continued free allocation to large industry sectors. Therefore, ensuring that free allocation (to the extent that it continues) benefits, and not harms, very low-carbon producers is important.

In summary, the key points and recommendations discussed within this policy brief are:

  • ETS free allocation could in part actively support low- and zero-carbon production by introducing a new ‘zero-carbon’ benchmark.
  • The zero-carbon benchmark would reward zero-carbon producers with additional free EU ETS allowances (EUAs), to (partly) cover their investment costs. The zero-carbon benchmarks can then be defined by applying a multiplication factor to existing benchmark values (e.g. 1.5 or 2.0). Every tonne of climate-neutral goods a producer puts on the market would be rewarded by this higher benchmark.
  • No additional free allowances are needed (the existing cross-sectoral correction factor would still apply). The available supply of EUAs would simply be redistributed in such a way that it benefits very low-carbon producers, so long as they produce climate neutral goods.