EU ETS Review: Free Allocation Investment Conditionality
Author(s): Andrei Marcu, Philippe Chauveau, Alexandra Maratou, Elizabeth Lesaulnier
This report examines the clause in the European Commission’s 17 July proposal that makes free allocation conditional on investment in decarbonisation. Under the proposal, 80% of eligible free allocation would depend on submitting an Invest in the EU Decarbonisation Plan approved by the Member State. The remaining 20% would depend on implementing investments in the EU at least equal to the economic value of the full free allocation received. The report also explores alternative approaches to investment conditionality, building on the ideas presented in ERCST’s second report.
It provides:
• An overview of existing conditionalities in the EU ETS and in European State aid frameworks
• Conceptual considerations
• The consequences of the clause for competitiveness and market functioning
• Uncertainties regarding, for example, the content of the plans, the exemption rules and the relocation clawback clause
• Alternative pathways
The report argues that the proposed approach raises important conceptual and practical challenges. Positive conditionalities that reward investment already exist. However, by tying existing free allocation to investment, the proposal risks turning it from a carbon leakage protection tool into a decarbonisation subsidy. It also raises concerns for both the competitiveness of covered industries and the functioning of the carbon market, including price volatility and interactions with the Market Stability Reserve. Significant uncertainty remains over key elements, including what plans must contain and which installations would be exempt.
The report’s preferred approach is to strengthen the business case for decarbonisation through supportive instruments such as Carbon Contracts for Difference, direct investment support and demand-side policies for low-carbon products. If conditionality is retained, obligations should in turn depend on the availability of technically feasible solutions, infrastructure and competitively priced low-carbon energy (“double conditionality”).
The report then puts forward two alternative pathways. The first is a positive conditionality pathway, which keeps 100% baseline free allocation. On top of that, a bonus layer of free allocation would reward installations that voluntarily submit a verified plan and deliver verified decarbonisation milestones. The second is a simpler, more flexible way of demonstrating decarbonisation investment. Companies would show at corporate or group level that the value of their free allocation went to decarbonisation, using existing financial disclosures and recognised certification schemes rather than dedicated installation-level plans
