The distribution of free allocation has become a highly contentious issue within the Phase IV European Commission proposal. The objective of free allocation is to safeguard industries from unfair competition, particularly when products from outside the EU face no additional costs due to a lack of environmental policies.
According to the European Commission's revision of the EU ETS for Phase IV, free allocation will continue as long as other major economies do not undertake comparable efforts. The aim is to provide appropriate support to sectors at risk of losing international competitiveness. One significant change in free allocation is the increase in the Linear Reduction Factor from 1.74% to 2.2%. This reduction factor decreases the total number of allowances available for free allocation by 556 million tonnes over the Phase (equivalent to the annual emissions of the UK).
Under the current EC proposal, Phase IV allocation procedures will be more dynamic, ensuring flexibility in the face of production fluctuations, increases, or plant closures. The objective is to prevent windfall profits from surplus allowances in the event of significant production decreases, while adequately compensating installations for higher production and emissions levels in case of increases. The New Entrant Reserve will absorb excess allocations resulting from production decreases and provide additional allocations for increases.
Allocation and benchmarking figures will be revaluated and split into two five-year phases to accommodate technological advancements and changing production levels. Benchmarking figures will also be gradually reduced by approximately 1% per annum to better reflect technological progress. Surplus allowances from Phase III can still be banked for use in Phase IV.
Changes to the carbon leakage list are also crucial when considering free allocations. The current EC proposal aims to reduce the number of sectors on the list from 180 to 50. Additionally, countries like France and the UK have advocated for a more tiered approach to the leakage list instead of the current binary classification. This approach may lead to a reconsideration of the original plan, altered by the EC proposal, to completely phase out free allocation for industries not exposed to carbon leakage by 2027. Currently, these industries are set to receive a maximum of 30% of their benchmark allowances.
