According to the European Commission, “Carbon leakage refers to the situation that occurs if, for reasons of costs related to climate policies, businesses in certain industry sectors or sub-sectors were to transfer production to other countries with less stringent emission constraints.” For example, a company located in Spain and captured by the EU ETS may decide to move production to North Africa to avoid the cost of carbon if the cost is too high. Not only would such a development destroy jobs in the EU, but it would also run the risk of increasing emissions (for example if production were to shift to a less efficient plant), thus running the risk of cancelling out the efforts made by the EU to curb emissions. Free allocation is distributed to address such competitiveness concerns by lowering the effective carbon costs for energy intensive industry sectors and sub-sectors that cannot pass the cost of carbon on to their customers through higher prices.

How is it calculated?

In Phase III a sector or sub sector is deemed at risk of carbon leakage if they meet the following criteria;

  • direct and indirect costs induced by the implementation of the directive would increase production cost, calculated as a proportion of the gross value added, by at least 5%; and
  • the sector’s trade intensity with non-EU countries (imports and exports) is above 10%.

Or alternatively, they are deemed exposed if

  • the sum of direct and indirect additional costs is at least 30%; or
  • the non-EU trade intensity is above 30%.

The criteria to calculate carbon leakage exposed sectors and sub sectors will change in Phase IV and will dramatically reduce the number of sectors and sub sectors protected. We’ve written a free guide to how companies in the EU ETS will be affected by the new Phase IV carbon leakage list and what they need to do by when. Please contact us and we will send you a copy.

Protection for those on the carbon leakage list

If you are included on the carbon leakage list you will receive 100% of your calculated free allocation based on the applicable benchmark, subject to the application of the Cross Sectoral Correction Factor. Those not protected by the carbon leakage list will receive a maximum of 30% of the calculated free allocation based on the applicable benchmark.