Refund policy

Welcome to Carbon Risk — helping investors navigate 'The Currency of Decarbonisation'! 🏭.

Europe's industrial companies do not pay the full price of carbon – not even close.

Free allowances are a common feature of emissions trading systems in the early phases to help companies get used to the administrative and compliance burdens, and to protect those sectors thought to be most at risk from carbon leakage.

In the EU ETS, many heavy industries received far more allowances than they needed.

It enabled them to bank windfall profits, primarily through cost-pass-through, but later by selling EUAs back into the market. A study by CE Delft, commissioned by Carbon Market Watch estimated that the fifteen most carbon intensive sectors generated between €30 and €50 billion in additional profits during 2008-2019.

The allocation of free allowances clearly tampers with the carbon price incentive that would otherwise encourage large industrial emitters to invest in decarbonisation.

Up until the past couple of weeks the assumption was that free allocations would be gradually withdrawn at the same rate that CBAM costs on importers were introduced. In short, it would mean that by 2034 free allocations would drop to zero. However, concerns over the competitiveness of Europe's industries has increased, with policymakers openly debating whether the bloc should taper the rate at which free allowances are withdrawn, and make their their use conditional on industrials investing in decarbonisation (see Cap-and-Invest: Europe set to leverage its carbon markets to boost investment in decarbonisation).

While free allocations affect the direct carbon cost paid by industrials (via their Scope 1 emissions), companies may also face paying for carbon indirectly, via higher power prices.

Three factors mean that Europe's industrial companies pay a high price for electricity. First, Europe's reliance on expensive imported LNG means that natural gas prices are ~3 times higher than the US. Second, natural gas sets the marginal price of electricity almost two-thirds of the time in Europe (despite accounting for 20% of the generation mix), and included within this is the price of carbon borne by gas-fired generators. Finally, non-wholesale costs such as government investment in grid modernisation, as well as other policies such as social funding, are recovered through the electricity tariff.

Indeed, some reports suggest that the price of carbon accounted for the majority of the divergence between European and US power prices in recent years.

First introduced in 2013, today around half of the EU member states offer compensation to certain trade-exposed energy intensive companies for their indirect carbon costs, typically those industries thought to be at most risk of carbon leakage. To avoid distorting the EU's internal market governments must adhere to strict state aid rules, any scheme must be approved by the European Commission, and they must limit compensation to 25% of their ETS revenues. Overall, 15 member states paid €5.52 billion in indirect carbon cost compensation in 2024, an increase of 40% compared with the amount disbursed in 2023.

In December 2025 the Commission extended the list of industrial sectors eligible for compensation to include 20 additional sectors as well as two new subsectors. Furthermore, for those sectors already eligible it also raised the maximum share of indirect carbon costs that can be compensated from 75% to 80%. Finally, the guidelines also strengthen the principle that compensation - particularly for major beneficiaries of the schemes - should be linked to measures that reduce exposure to carbon costs.

Despite the scale of the compensation doled out to date, the commitment by many governments to continue with the payments until 2030 at least, and the potential distortionary effect on competitiveness and emissions, there is surprisingly little research into their impact.